Calculating Commercial Rent

For new commercial real estate investors, the lingo of the industry often poses a major obstacle - especially if you’re used to how things are done in the residential real estate world. Commercial real estate professionals toss around unique phrases like “triple net lease,” “cap rate,” and “build out,” expecting you to understand. 

And, one of the major differences between commercial and residential involves rent calculation.  While residential typically involves a single, monthly amount, commercial rent uses a square-footage-based calculation, which can appear far more complicated to new investors.

As such, I want to use this article to explain exactly how to calculate commercial rent.  Specifically, I’ll dive into each of the following topics:   

·       Commercial Rent Overview

·       Useable versus Rentable Square Footage

·       Lease Structure 1: Triple Net (NNN)

·       Lease Structure 2: Full Service Gross (FSG)

·       Lease Structure 3: Modified Gross (MG)

Commercial Rent Overview

In the following sections, I’ll talk about the elements that make calculating commercial rent complicated, namely rentable versus useable square feet and different ways leases can be structured.

However, investors should first understand one major difference between residential and commercial rent quotes.  With residential, prices are quoted per unit.  For instance, an apartment may be listed for $1,200/month. 

With commercial properties, prices are listed by square footage.  Commercial spaces can be combined or divided, so this system provides investors and potential tenants a single number to quickly compare different properties, regardless of size.  

While some states list monthly commercial square footage rates, it’s far more common to see annual prices listed.  For example, ignoring lease structure, assume you see a 3,000 square foot office space listed for $30/sq. ft. (per square foot).  Here’s how those numbers translate into a monthly amount:

·       Total annual rent = 3,000 sq. ft. x $30/sq. ft. = $90,000/year

·       Total monthly rent = $90,000 / 12 months = $7,500/month

Instead of these calculations, wouldn’t it just be easier to provide a single monthly number? 

Well, as the following sections will demonstrate, a few more complications exist that don’t allow for such simplicity.   

Feel free to drop us a note if you need help analyzing commercial rent trends in your market.  This analysis can seem challenging, and we’re happy to help!

Useable versus Rentable Square Footage

While the above outlined a basic example of calculating commercial rent, the process becomes more complicated by that fact that some leases are quoted in useable square footage, while others are quoted in rentable square footage:

·       Useable square footage (USF): This is the square footage that you alone can occupy and use.

·       Rentable square footage (RSF): This includes all USF but adds in a pro rata portion of the common areas all tenants can access and need to maintain (e.g. lobbies, hallways, shared restrooms, etc.). 

Calculating commercial rent on a USF basis uses the straightforward formula above (ignoring lease structure, which I’ll discuss in the next sections).  On the other hand, calculating rent quoted in an RSF basis adds in the following additional calculations.  Assume the same $30/sq. ft. and 3,000 sq. ft. office from above, but now assume that the total property square footage is 100,000 sq. ft. with 10,000 sq. ft. of common area.

·       RSF factor (determines each tenant’s share of common area responsibility on a pro rata basis): Divide total shared space square footage by total property square footage.

o   Example: 10,000 common area sq. ft. / 100,000 total sq. ft. = 10% RSF factor

·       Your common area responsibility: Multiply USF by RSF factor.

o   Example: 3,000 USF sq. ft. x 10% = 300 common area sq. ft.

·       Your total RSF: Add your common area responsibility to USF.

o   Example: 3,000 USF + 300 common area sq. ft. = 3,300 RSF

·       Your annual rent on an RSF basis: Multiply your RSF by the quoted price per sq. ft.

o   Example: 3,300 RSF x $30/sq. ft. = $99,000/year

As these examples demonstrate, quoting rent on a USF basis resulted in $90,000/year in rent, while the rent quoted in RSF totaled $99,000/year, demonstrating why you need to understand whether quoted rent uses a USF or RSF basis. 

Lease Structure 1: Triple Net (NNN)

Now that you understand 1) the basic calculation of commercial rent using the square footage convention, and 2) the difference between USF and RSF, the next complication involves the actual lease structure.  While commercial leases can technically be structured however the landlord and tenant agree, three broad categories of common lease structure exist.

With a triple net lease (a.k.a. NNN or “net, net, net”), rents are quoted in a base rent plus additional expense format.  More precisely, tenants pay all of the following elements:

·       Their base rent (quoted on a per square foot annual basis)

·       NNN, or triple net expenses (also quoted on a per square foot annual basis):

1.     Common area maintenance

2.     Property tax

3.     Property insurance

·       Utilities (paid entirely by the tenant so not quoted in the lease)

Of note, the total NNN expenses can fluctuate on an annual basis, so they are typically quoted as estimates, meaning that tenants should closely review exactly what they’re responsible for prior to signing a lease. 

Now, assume the example used above is a triple net lease.  Here’s how it could be quoted:

·       $30/sq. ft. triple net base rent plus estimated $3/sq. ft. triple net expenses 

Commercial real estate professionals can help you identify NNN investment opportunities for your market and unique situation.  Need help connecting with reliable ones? Drop us a note!

Lease Structure 2: Full Service Gross (FSG)

On the opposite side of the commercial lease spectrum, full service gross (FSG) leases are quoted on an all-in basis, and the tenants don’t pay anything above and beyond the quoted rate. 

The landlord collects a single fee from the tenant and is then responsible for paying all associated property expenses (e.g. common area maintenance, property taxes, insurance, etc.).  As a single rate, FSG leases tend to be far simpler for both tenants and landlords. 

Assuming our example is an FSG lease, here’s how it would be quoted:

·       $30/sq. ft. full service

Lease Structure 3: Modified Gross (MG)

The final broad category of commercial lease, modified gross (MG), exists as a hybrid between triple net and FSG leases.  Rather than select one of those options, the landlord may pass on any property expenses outlined in the lease.

For example, if the above example was quoted as a MG lease, with the tenant responsible for in-suite janitorial expenses, here’s how it would be quoted:

·       $30/sq. ft. MG net* of janitorial

*In this context, net simply means that the expense is the tenant’s – not the landlord’s – responsibility. 

With an understanding of the annual square footage convention, RSF versus USF, and different lease structures, you can now quickly and confidently calculate commercial rents. 

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We recognize that, even after outlining the above information, calculating commercial real estate rent – and determining what lease structure best fits your needs – can seem daunting.    

That’s why we’re here to help.  The Pocket Broker team lives and breathes commercial real estate, so drop us a note to see how we can help you achieve your unique objectives!