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How to Navigate the Commercial Property Rental Marketplace

Posted: 24 Jan 2014

BLOG NOTE: This blog post is from a previous season. To view our most recent blog posts, click here.

Understanding how commercial rents are structured and comparing rents on different spaces can be confusing to many. Commercial rents basically have four components: 1) the base, 2) additional rent that includes the tenant's share of the Common Area Maintenance fees, or CAM, the buildings insurance and real estate taxes, 3) an annual escalation factor, and 4) often some type of rent abatement at the beginning of the lease.

The base, or net rent component, is the actual net rental income that a landlord receives from a particular space over and above the building's operating expenses. This is often used by tenants to compare the costs of different spaces; however, this simple type of comparison can be misleading as we will discuss below.

The CAM fees typically are the annual common operating expenses of the building that covers everything utilities for the common spaces, trash, sewer, water and snow removal. These expenses typically are shared by all the tenants in the building proportionally, based on the comparative sizes of each tenant's space.

In addition, the insurance on the building and real estate taxes also are divided proportionally among the tenants and added to the CAM fees to make up the additional rent. Negotiating what's included in the CAM fees is one of the trickiest parts of negotiating a commercial lease.

In a market such as Aspen, CAM fees can range from as low as $10 per square foot to as high as $22 per square foot. Often times, landlords try to include capital expenses in CAM costs.

Although everything in a commercial lease is open to negotiation, the standard practice in the commercial real estate industry with a multi-tenant building is that the landlord pays for capital expenses and the tenants pay for annual operating expenses.

Capital expenses, as defined in the commercial real estate industry, are generally expenses that are capital improvements to the building that have a lifespan greater than a year, such as a new roof that might last for 20 years or more, or a new mechanical system that could have a multi-year lifespan. The theory is that a tenant should only have to pay for expenses that relate to the annual ongoing care and maintenance of a building during the term of their lease, and not for costs that are capital in nature and will outlast the tenant's occupancy of the building.

The other two lease components of a commercial lease are the annual escalation and the rent abatement period. The annual escalation is a percentage increase each year applied to the base or net rent. The theory behind the annual escalation is that the base rent should increase at a rate comparable to inflation and the overall increase in market rents. This normally can range from 0 percent to 6 percent depending upon the overall terms of the lease.

The rent abatement normally applies at the beginning of the lease where the base rent, but not normally the CAM fees, is abated for a certain number of months or weeks to allow the tenant to get open for business, or as an incentive by the landlord to get the tenant to lease the space.

Typically, a commercial tenant is looking at several spaces at the same time and trying to compare the economics of each space when each space has a different rent structure with different base rents, CAM costs and annual escalation factors. Tenants often are trying to compare apples to oranges when it comes to figuring out the comparative economics of each space.

The most accurate method of comparing the economics of different spaces is the Discounted Cash Flow Method. The Discounted Cash Flow Method takes each of the rent components of each space projected out the term of the lease and then applies a discount percentage to calculate a present value of the cost of the lease. These values can be compared to see which rent structure is most economical.