How is Commercial Rent Calculated?

Posted on October 27, 2020

Has your small business outgrown the basement? Are you ready to expand into a commercial real estate (CRE) property? Whether you’re a new hopeful or a seasoned entrepreneur, securing a new location for your company is an exciting experience. But understanding the common ways CRE rent is calculated is important to protect your future profitability and, ultimately, business prosperity.

What Do You Need to Know Before Signing a Lease?

Before diving into how much you might expect to pay in rent for a new space, understand that there are several types of CRE leases. And your total operating costs for the property will vary, depending on the type of agreement. For instance, a triple net lease most often leaves the tenant responsible for covering the majority of the property’s expenses, in addition to the monthly base rent. There are pros and cons to each common CRE lease, so make sure you fully understand the type of lease you’re signing to avoid any hidden costs. It’s a good idea to find an experienced CRE broker to help guide you in this potentially confusing process.

The type of CRE lease is commonly, although not always, determined by the type of business you operate and the environment you’ll need to run it effectively. Whether you need a storefront in a busy area to bring customers through the doors of your retail operation or a quiet office building to get some uninterrupted work done, there’s a common CRE space to fit your needs.

Experienced CRE Brokers can Help Guide Business Owners

How is Commercial Rent Calculated?

There are multiple ways CRE rent is calculated, but here we’ll cover the two most common methods.

Rent Per Square Foot

Rent is set at a certain dollar amount per square foot. This has the potential to be confusing, as there are distinctions between rentable, usable and gross square footage. And the actual square footage that makes up your monthly rent is usually more than the space that your company inhabits.

Usable square feet is what you may think about when looking at CRE properties. This is defined as the total area unique to a tenant. When you walk through those doors, the area between the walls is the usable square feet. This is where your company will “live.”

Rentable square feet is different. It’s defined as the usable square feet, plus a portion of the building’s common space, such as lobbies, hallways and public restrooms. The base rent of a CRE property is determined on rentable square feet, not usable.

Gross square feet is simply the total square footage of a building and typically has little bearing on the cost of rent. However, it’s still good for tenants to understand these three definitions of square footage.

To calculate rent, take the cost per square foot and multiply it by the rentable square footage. Now, it’s important to understand that some leases have an annual price per square foot, others are considered monthly. For a 1,000-square-foot office space, the calculations may look like this:

  • Annual: $25 per square foot X 1,000 = $25,000 per year
  • Monthly: $2.08 per square foot X 1,000 = $2,080 per month X 12 months = $25,000 per year

Rent per square foot is far and away the most common method for determining CRE rent. However, if you’re in the retail business, there’s an approach common with these specific types of properties—the percentage lease.

Percentage Lease

These leases have a base rent, then require a percentage of the company’s monthly sales on top of that. These agreements rarely require a percentage of all sales, rather a share of the sales that exceed the “breakpoint.” This is the point at which the landlord will require that you begin paying a percentage of sales, as outlined below:

  • A landlord requires a tenant to pay 7% of total sales over a “natural breakpoint.” What’s a natural breakpoint? Using a hypothetical base rent of $25,000 per year, take the base rent amount and divide it by 7% (0.07) to arrive at $357,142. This means that 7% of sales exceeding $357,142 per year would go to the landlord.
  • So, if this hypothetical store made $500,000 in a given year, it would subtract the natural breakpoint of $357,142, for $142,858 worth of sales over that breakpoint. And 7% of $142,858 would require roughly $10,000 to go to the landlord.

There are other ways breakpoints may be determined. But the “natural breakpoint” method illustrated here is the most common. And although used hypothetically here, 7% is a common percentage to expect to see among these types of leases.

Help for all Your Commercial Real Estate Needs

There is a lot to navigate when considering a CRE space. And negotiations can be complex and intimidating. It pays to have an experienced and knowledgeable broker on your side. Chris Falk has the specialized experience needed in these negotiations. Contact him for any of your questions or CRE needs at (801) 416-1024 or chris.falk@ngkf.com.