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What is load factor and why does it matter?

12/31/2020

 
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Office tenants always understand that you can’t determine rent without the asking rent and rentable square footage (RSF). What they often don't understand is that load factor is just as important to the calculation of their rent. 

If you require a set certain amount of office square footage, understand that not all office spaces with the same advertised rentable square footage and the same asking rent are the same. 

Usable Square Feet (USF) 

One of the first steps in planning for office space is to determine how much usable space you need. These “rules of thumb” can help estimate the amount of usable square feet required for your business based upon uses.

So far, the math is pretty simple. Determine the number and size of offices, conference rooms, etc... plus an estimate of space needed for circulation (hallways/corridors) and you can roughly estimate your usable space requirement. 

Simply put, usable square footage is the actual and exclusive space you occupy inside your suite where you conduct your business. Usable square footage does not include common areas of a building such as lobbies, shared restrooms, stairwells, storage rooms, and shared hallways.
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Now that you’ve developed an estimate of the amount of space you’ll need, it should be pretty straight forward to identify the space alternatives that meet your size and budget requirements. But it’s not. Because, while tenants understand and think in terms of their usable space needs and budget limitations, available office space is typically marketed as rentable square feet. 

Rentable Square Feet (RSF)

Your rent will be based on rentable square feet so understanding the difference between usable square feet and rentable square feet is essential to evaluating alternatives. 

Rentable square footage is your usable (actual and exclusive) square footage PLUS a portion of the building’s shared or common space (lobbies, shared restrooms, stairwells, storage rooms, and shared hallways, etc..). Each tenant pays for these common areas in proportion to the amount of space they lease in the building. 

Since no two buildings have identical amounts of common area, you will rarely if ever find that two spaces listed with the exact same rentable square footage are equal in usable space. This is where the math stops being simple. 

Load Factor (LF)

The variable in your rent equation that accounts for these common areas is called the load factor. Load factors are typically represented as a percentage and commonly range between 10% and 20%. The formula to calculate your rent looks like this:
  • Useable Square Footage + Load Factor = Rentable Square Footage
  • Rentable Square Footage X Rental Rate = Rent
Understanding the load factor of the alternatives that you are considering is essential to determining the best size fit and value for your office space.

While you’d think that such an essential variable in the rent equation would be included in marketing collateral and industry databases, load factor is often not. In fact, it’s not uncommon for listing brokers to be uncertain or unaware of the building LF when showing space. Two things listing brokers like to withhold in tight markets, the asking rent and load factor. (More on Asking Rent: WITHHELD).

For example, two alternatives are marketed with the same size (10,000RSF) and asking rent ($60.00/RSF/YR) may appear equal but they aren’t. When you include the differences in load factor (20% vs 10%) you gain 757USF (9,090USF - 8,333USF) in option 2 for the same rent as option 1.
  • 10,000RSF with 20%LF = 8,333USF
  • 10,000RSF with 10%LF = 9,090USF
 From a tenant’s perspective, the "usable" rental rate is:
  • (10,000RSF X $60)/8,333USF = $72.00/USF/YR
  • (10,000RSF X $60)/9,090USF = $66.01/USF/YR

So, while the two alternatives are marketed as the same size (10,000RSF) and asking rent ($60/RSF/YR), alternative 2 is a better value at $66.01/USF/YR based on a lower load factor. 
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That is why load factor matters.

What Every California Tenant Should Understand About Property Tax Liability

12/4/2020

 
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As tenant representatives, we advise our clients that ownership matters. The differentiator between two similar buildings and spaces with like amenities and rent can often come down to the quality of ownership. Buildings that have been owned and managed by the same entities for a long period of time tend to be better managed.  

 Under Proposition 13, buildings like these may not have been reassessed at market value for years and in some cases decades. Proposition 13 was approved by 65% of California voters in 1978 and currently limits property tax reassessments (increases) to 2% annually but allows for full tax reassessments if the building is sold, more than 50% is transferred, or substantial new construction is completed. 

In California, commercial landlords typically pass on a pro-rata share of building operating expense (OPEX) including property taxes to their tenants. In the most common “full service” office lease, tenants are only responsible for OPEX increases over the “base year” amount which is most often the year of the commencement date or the year following the commencement date. 

​As a result, tenants in buildings that have been owned by the same entities for a long period of time carry a large tax liability if the property is sold or transferred during the term of their lease. In San Francisco, tenants with the largest pass-through liability are looking at as much as $10 per square foot per year for the remainder of their lease if the property is sold and reassessed.

 Why is property tax liability a third rail issue for brokers?

The differentiator between two similar buildings and spaces with like amenities and rent may come down to the size of a tenant’s property tax liability. For this reason, w
e do the math on the property tax liability for every alternative we put in front of our clients.

As a brokerage working exclusively for tenants we always pursue some level of protection for our clients by seeking a cap on OPEX (including property taxes) increases throughout the term of the lease. Not having cap on property tax increases can be devastating for tenants but building owners are extremely resistant to agreeing to this protection. Simply put, commercial property is harder to sell if tenants have OPEX caps. So, it’s understandable that landlords are somewhat inflexible and seek to pass the full tax reassessment burden onto tenants. 

 
For the last decade only the largest tenants in softer markets have been able to negotiate caps on OPEX increases. But a black swan event like the coronavirus pandemic shifted leverage in markets that once favored landlords to favoring tenants overnight. Seeking and obtaining OPEX protection is easier said than done but it should always be subject of negotiation. 
 
Somewhat harder to explain and understand is why property tax liability is a third rail issue for brokers. The dirty little secret in commercial leasing is that most commercial real estate brokerages represent both tenants and landlords which creates a built-in conflict of interest. If your broker isn’t discussing your property tax liability or seeking a cap on OPEX, it’s probably because like a third rail, touching it is extremely dangerous for their business.  
 
At a minimum, it’s important to do the math on your property tax liability before entering a lease in any building in California. Tenants need to know when the property was last reassessed for Proposition 13 purposes, what its assessed value was and what its assessed value is today to forecast the potential liability due to a transfer of ownership. The longer it’s been since the last reassessment, the greater your exposure to property tax increases.

    Kevin Cronin

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