Lease rates for industrial properties in Southern California continue to rise!
To place this in some context, if your direction as a business owner was to rent a location in 2011 and your operation consumed 100,000 square feet, you could expect to pay around $45,000 per month in rent.
Of course, charges for things like property taxes, insurance and maintenance would have been in addition to the $45K. Those additional charges would have added around $12,500 per month, bringing the total to $57,500 – or 57.5 cents per square foot.
Flash forward to our pandemic-fueled shortage of space these days and comparable buildings lease for $135,000 per month!
For those scoring at home, that’s a 134% increase in 10 years. Or, a 13.4% annual increase. Or as I like to call it, simply nuts!
Am I saying if you rented an address in 2011 and signed a 10-year lease – when your lease expires this year – you can expect your rent to more than double? Yes, You got it.
So, how are businesses able to afford such a whopping spike? Better still, are there strategies you can employ to stem the rent bumps? The answers are, I don’t know and yes. Indulge me as I outline a few ways to lessen the blows of gigantic rent inflation.
Know your owner
The gentleman to whom you send your rent each month falls into the category of investors. Your tenancy is singular or multiple. Unfortunately, if you’re one of many and his buildings are full, your leverage is limited.
You see, he may opt to push rents even if a move-out ensues. He’ll simply replace you. Conversely, if your rent is the biggest part of his retirement income, a bit more realism happens. If you relocate – and his music stops – so does his lifestyle. He’ll be more flexible with you to keep you in residence and avoid a costly vacancy.
Know your value
As a tenant, your worth is two-fold.
First, the capitalized income you pay each year determines the dollar amount of the investment. Simply, $100,000 in annual rent – at today’s cap rates of 4.75% suggests $2,105,263 ($100,000/4.75%) – if a sale or refinance was considered.
Why is this important? A bank would lend a percentage of this amount if your owner needed cash. Plus, the market would gladly pay him this figure if a decision was made to cash-in or redeploy the money into another income property.
Second, your tenancy is costly to replace. By this, I mean free rent, downtime, refurbishment, and professional fees are forked over to secure a paying customer.
So, let’s say the title holder of your location believes he can get $100,000 a year if you bolt. You currently pay him $80,000 annually. If he’s correct in his assumption, he can achieve approximately $538,406 if he finds a five-year tenant ($100,000 with a 3% annual rent escalator).
However, if he lays fallow for two months, incentivizes the new group with one month of free time, paints and carpets the offices, and pays a commercial real estate professional 6%, count on an up-front expenditure of $72,303 – ($16,666 for downtime, $8,333 in free rent, $15,000 for a fix-up, and $32,304 in fees).
If we subtract $72,303 from our expected new income stream of $538,406 our net take is $466,103 or $93,220 per year.
Say you’re willing to pay him $90,000. So, he could be slightly better off replacing you. But, if any of his assumptions are wrong – say, he sits four months vs. two, he is better off renewing you at $90,000 annually.
Presumably, you’ve paid on time, taken care of the premises and sent him a Christmas card. Those intangibles have credibility. He may have to chase the new guy to get his rent.
Know your alternatives. Don’t forget. You could buy a building, consider a cheaper area or opt for a shorter lease term.
More on these later.
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at email@example.com or 714.564.7104.
Source: Orange County Register