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The effects of Covid_19 will have far-reaching consequences from now into the future. No area probably more than the Real Estate market.
In fact, one area where the turmoil has created opportunities for entrepreneurs is in renting real estate space.
“Overall, this has become a tenant’s market,” says Stuart Siegel, executive managing director for real estate broker Grubb & Ellis in New York City. “There are probably more small businesses that are nimble and able to act quickly during this crisis. They can capture landlords who are vulnerable and get anxious to make a really terrific deal.”
While the standard adage for businesses that want to rent space is that bigger is better, “We are seeing a lot more activity with smaller tenants now than larger ones,” Siegel says. “A lot of big companies are downsizing, cutting costs and putting space on the market for sublease.”
As a result: “Rental prices are coming down across the board from top triple A office buildings in New York City to strip malls and freestanding office buildings in smaller markets,” he says. “Tenants can often make numerous offers to see which landlord is the most vulnerable. It’s similar to the residential market, where vulture buyers are seeing who bites.”
Sherry Cushman, a senior vice president for CB Richard Ellis in Washington, D.C., who helps law firms finds space all around the country, has a client that wants to open an office in New York City with 10,000 square feet of space.
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“When they started looking eight months ago, they couldn’t touch anything for below $70 per square foot, and most of what they were looking at was $90 to $100 per square foot,” she says. “Now the range is $50 to $70.”
The national office vacancy rate jumped to 14.8 percent at the end of last year from 13 percent 12 months earlier, according to Grubb & Ellis researchers. And they see things getting worse.
“Expect leasing market fundamentals to deteriorate more sharply in 2009 in response to very difficult economic conditions,” they wrote in a recent report. That, of course, is good news for small businesses looking for space.
6 tips on searching for space
Here are six key points for small businesses to keep in mind when searching for space to rent:
- Smaller is better
- Get the duration you want
- Ask for concessions
- Don’t expect slack on your security deposit
- Learn your market
- Investigate your landlord
1. Smaller is better
“The opportunities are there for small businesses,” Siegel says. “Landlords that hadn’t contemplated pursuing smaller tenants are now looking to diversify and are willing to take small tenants in previously large spaces that are now divided into smaller ones. The number of small spaces tenants can consider in their searches has increased.”
2. Get the duration you want
Whether you are looking for a one-year lease or a 10-year lease, you have a good chance of getting your wish. “In good times, landlords could say, ‘We’re only doing five-year leases.’ The strong demand could get them that, and they wouldn’t have to negotiate,” says Jake Harrington, director of business development for On-Site.com, which helps landlords screen tenants.
Now things are different. “My associates are working with small and big businesses,” says Rob Cochran, managing principal of Colliers Pinkard’s Charlotte, N.C., office. “Maybe they have two to three years left on their lease. They can renegotiate for a longer-term commitment. Now is a good time for that.” If you’re a startup, you’ll want to negotiate as short a lease as possible, since you don’t know how long you’re going to be around. On the other hand, if your business is thriving, you should consider locking in today’s cheap rent for a long-term lease.
Small business guide
3. Ask for concessions
“Don’t take the price of the lease at face value,” says Rich Sloan, co-founder of StartUpNation, a Web site that assists small businesses. “Landlords are hungry to earn revenue from properties — hungrier than conceivably they’ve ever been because of the difficult economy. Try to lock in lower-than-advertised rent.”
What landlords like to do is offer tenant improvement dollars, subsidizing renovations for a space, or a period of free rent. “That way word doesn’t have to get out that rent is going down,” even though effectively it is, Siegel points out. You also may be able to negotiate a limit to future rent increases.
With all the monetary stimulus the economy is receiving, inflation likely will accelerate in coming years. Often lease rates rise in synch with the consumer price index. “Tenants should put a cap on that, saying annual increases aren’t to exceed 2 (percent) to 3 percent,” Harrington says. “You don’t want to get stuck with an 8 percent increase.” You often can negotiate an option to expand your space if you need more down the road. And you may be able to get the landlord to pay for management fees, janitorial expenses, maintenance and repairs. Sloan suggests negotiating for perks like parking spots, garbage removal and snow-clearing services if you’re in the north.
4. Don’t expect much slack on your security deposit
“This is more of a problem because landlords are concerned about the risk” of tenants failing, given the recession, Cochran says. “People are really looking at credit risk. If you’re already in a space, it’s probably not an issue.” But if you’re taking new space, be prepared to pay about 10 percent of your lease total as a deposit. “Landlords will typically require a letter of credit, and small businesses may be required to make a personal guarantee” to pay the deposit, CBRE’s Cushman says.
Small business tenants often aren’t aware of how important the security deposit is to a landlord, Siegel says. “Landlords don’t want to pay tenant improvement dollars and make other concessions and then get the space handed back to them six months later,” he points out. One exception to this rule: subleases. Companies that have too much space and thus must rent some out to other firms often aren’t in a position to ask for more than one or two months’ rent as a security deposit.
5. Learn your market
“It’s important for the tenant to be educated,” Siegel says. “Now is the time to see a lot of space.” He recommends working with a broker. “Very often small business owners feel they can find space and negotiate a lease on their own,” he says. “But I’m not sure they understand things like how a personal guarantee differs from a good guy guarantee.
“There are many nuances, such as escalator clauses, renewals, expansions and possible termination rights, where terms can be favorable to you in this economy if you know how to ask. Without a broker, you run the risk of the landlord taking advantage of you. A good broker and a good attorney will protect a tenant.” You don’t have to spring for a lawyer until you’re ready to sign a lease, Siegel says. But he emphasizes the importance of using a real estate attorney. “Attorneys who handle regular corporate legal work might not be the right counsel for a complicated commercial lease,” he points out.
6. Investigate your landlord
That’s especially important in this economy, where many major real estate holders are taking it on the chin. “The creditworthiness of a building owner is very important,” Cushman says. “Are they restructuring a loan they can’t repay? Are they in some kind of trouble? It used to be that you’d just look at the tenant. Now you have to look at both sides of the table. In the larger deals, we almost always run a credit check on the owner.”
The bottom line:
This is a great time to be looking for space. “I don’t think you’ll see opportunities this significant for a long time to come,” Siegel says. “It’s hard to time the market precisely, similar to the stock market. But a time when the market is in transition and landlords are nervous is a good time to act. A lot of people don’t know what the values really are for their spaces. So it’s a neat time for tenants to strike very attractive deals.”
If you’re a current business owner wondering if your rent is too high, please read our article: Local business owners: Are you paying too much in rent?
We’ll discuss the “average cost of rent for small business” in several metro areas, and we’ll show you why this isn’t the most helpful way of determining what you might expect to pay for rent.
You’ll also learn how to use unit economics calculations to determine if your business is profitable enough to start paying rent for commercial space.
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The average cost of rent or office space for a small business varies widely, even within cities
When you’re trying to estimate how much business rent might be in your area, it’s helpful to try to research the average rent for a small business in your area.
Start by asking around your proposed area to get some idea of what it MIGHT cost you to do this. Of course, since the three most important things in real estate are (you guessed it) location, location, location, you will likely find widely varying rent figures depending on how good the location has been determined to be (and on your industry).
You should also consult with your local real estate brokers (as well as local business owners) to get a better idea of how much you might expect to pay. Be sure to clarify whether they’re quoting you the price per square foot PER YEAR, or per month.
It’s common to use the yearly figure but some industries or realtors might standardize on a monthly figure. For our purposes we are going to assume that the price per square foot is the yearly price unless stated otherwise.
If you want a prime storefront with lots of exposure and traffic in a typical suburban area, you can expect to pay quite a bit more, even more than double, what it might cost you a few blocks away.
The “good spot” in a popular shopping area might be $25 per square foot, while a less swanky location could be $10 or $11.
So for 2,000 square foot of retail space, you’re looking at a potential rent cost difference of $30,000 per year ($2,500/month) in this example, based solely on location.
(Yearly price per sq. ft. x square feet ÷ 12 months = monthly rent)
The additional revenue generated by a prime retail location could make the extra cost of rent worth it, but it might not. You’ll need to examine your revenue and determine that for yourself (see below).
Be sure to ask about additional charges, insurance, and taxes over and above your commercial rent
IMPORTANT NOTE: Most commercial landlords will also charge you for “common area maintenance” (CAM), which is your portion of the cost for maintenance of the building, parking lot, etc.
They may also charge you for property tax, utilities, and your portion of the insurance premium they pay for the space.
In addition, for prime locations, a landlord may ask you to pay a percentage of your gross monthly revenue, or a percentage of revenue over a base amount (anything over $40,000 per month, for example).
These extra charges can potentially be hundreds or even thousands of dollars per month, so make sure you read the fine print carefully before you sign your commercial lease.
Examples of average cost for business rent per square foot by metro area
Even though you need to talk to a commercial realtor in your area to get actual figures, we can provide some idea of the average rent per square foot for several metro areas across the US.
Inc. has a helpful interactive commercial rent infographic that gives their 2017 data for some of the larger metro areas, so have a look around and see if your locale is listed.
Entrepreneur’s data is a couple of years older, but they published average commercial rent per square foot that can give you a ballpark idea, from the low $20s per square foot in Dallas and Atlanta, to around the $30s in Boston, Miami, LA, Seattle, Chicago, and Houston, climbing to the $50s for DC, and into the $60s and $70s for San Francisco and New York.
Note: Inc. cites numbers closer to $40/sq. ft. for New York City and San Francisco for retail space, which highlights the need to do your own research to get a more accurate idea of what business rent should be in your area.
However, if you are trying to decide whether it makes sense for you to move to your first (or a larger) rented business space, you really need to determine the “unit economics” of your small business.
Unit economics is a more helpful and accurate approach than “average business rent in my area”
Let’s look at a few theoretical examples to help illustrate the concept of unit economics:
- Let’s say you sell dinguses. One dingus costs you $5 to make (or purchase), stock, and sell. You sell the dingus for $10 retail. Looking at the unit economics, we see a 50% profit margin.
- We can also look at things in terms of cost of acquisition of a customer (CAC). Let’s suppose you have done the math and determined that for you to acquire one customer, it costs you $30, between product cost, marketing campaigns, employee expenses, and overhead. Your data shows the average customer typically spends $65 per visit. Looking at the unit economics in this example, your CAC is pretty high, but still positive.
- Next, let’s look at rent. We’ll assume one square foot of commercial space costs you $6 per month, and your average monthly gross revenue is $48,000. If your space is 1,000 square feet, that’s $6,000 a month in rent. Run the calculation ($6,000 monthly rent ÷ $48,000 monthly gross revenue) and your rent is 12.5% of your monthly gross income.
Let’s look more closely at this last example to tell if your small business rent would be prohibitively high based on your revenue and estimates of commercial rent in your area.
What percentage of a small business’s revenue should be rent?
To calculate this price to commercial rent ratio, we’ll look at some common “verticals” (types of businesses) and the typical rent levels of each. Keep in mind the following percentages are rough estimates and are not exact, but you might find them helpful in planning or benchmarking.
- Restaurants: Generally, a restaurant’s total occupancy cost (rent and additional fees for property taxes, insurances, etc.) should not exceed 6-10% of gross sales. (source)
- Hair salons: Combined commercial rent and property taxes for hair and nail salons range from 3% for a more remote location to 10% in a popular, well-established mall. (source)
- Law firms: Law offices may expect to spend 6-7% of gross revenue on rent, but this can climb as high as 15% for a prestigious address. (source and source)
- Retail stores: Retailers should aim to spend no more than 5-10% of gross annual sales on rent. (source)
- Auto shops: A typical full-service auto shop spends 12-13% of annual gross revenue on rent. (source)
The next thing we need to look at is your gross sales. How much money did your business make last year? What was the total sales for each month? Lots of small business owners know this figure very well, and if you don’t, you should.
Finally, you need to know (or estimate, based on your local research), your business’s square footage and rent cost.
Calculate how much your business should pay for rent
Gross sales ÷ square footage = sales per square foot
If your average monthly gross sales are $15,000 and you are considering renting a 2,000 square foot retail space, then your sales per square foot would be $7.50.
If monthly rent works out to be $2/square foot, divide your monthly rent per square foot by your sales per square foot to determine your percentage of income that would go toward rent.
2.00 ÷ 7.50 = 26.6%
If this number is higher than the average for your vertical—retail shops, in this example, at 5-10%—then you can be confident you would be paying too much in rent.
In our example, for every $7.50 in revenue that a square foot generates, $2.00—or more than one-fourth—would be going to the landlord. This is waaaay too much, according to the industry average.
However, if you think you can sell the same amount out of a 1,000 square foot space, then your rent would be around 13% of your gross revenue. This is still more than you should pay as a retailer, but much closer to the industry benchmark.
The calculation above shows the unit economics of your rent, broken down into the revenue and expense of a single square foot.
Why is this important? Because you can use the unit economics of your proposed space to decide whether you can afford to cover the cost of a business lease, or whether you should try to make your business more profitable first.