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The Back Office: Efficient Firm Operations
The firm should inquire not only about the ownership at each of the available office buildings but also about the property management company that the landlord has selected to manage the building. The building manager is often a tenant’s main point of contact in an office building and the individual to whom the landlord has entrusted responsibility for the maintenance and upkeep of the building. Thus, it is critically important that the property manager have a good working relationship with the current tenants in the building and that the building manager has demonstrated the ability to promptly resolve the various kinds of issues that arise in all office buildings, which can range from minor janitorial issues (e.g., keeping restrooms cleaned and stocked) to more significant engineering problems (e.g., f looding or mid-summer HVAC outages).
There are a wide variety of property management companies, from very small building management companies who are responsible for only a handful of buildings, to larger nationwide companies that manage buildings in many different cities. While the latter may provide the professional services firm with a higher degree of comfort, at least on a superficial level, the firm should nonetheless seek the input of other tenants about the building management company, as even the largest property management companies can experience varying levels of service between different cities and even between different buildings in the same city.
TENANTS.
Before the firm narrows down the list of office buildings to
those that it will visit and inspect, the firm should informally assess the other major tenants in the available office buildings. It is important that the firm determine whether any competitors are already tenants in the building and, if so, whether their presence would be an impediment to servicing existing clients or attracting new clients. For example, if an accounting firm (50 to 100 professionals) is considering office space in a number of buildings and one of those buildings is generally referred to by the name of one of its larger competitors (e.g., the KPMG Building), the firm should assess whether and to what extent its business would be impacted by the presence of that competitor. Additionally, the professional services firm should try to determine whether there are any unsavory or objectionable tenants in the building who might ref lect poorly on the firm.
PARKING.
Parking is one of the hidden costs that can add to the overall
expense of a lease; thus, the firm should ask whether parking spaces are included in the rent and, if so, how many spaces. The number of parking spaces that a landlord is willing to provide a tenant free of charge is usually determined by a predetermined ratio of parking spaces per square feet of leased office space. Thus, for example, if the total lease size is 10,000 square feet and the landlord is willing to provide one parking space per every 1,000
square feet of leased space, the tenant will be provided 10 parking spaces at
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477
no charge. (The term “no charge” is a misnomer because the landlord will have built the cost of parking into the rental rate.) In this example, any additional parking that the tenant needs would be paid for by the tenant, whose costs are often passed through to the professionals and employees employed at the firm. The cost of parking and the allocation of parking spaces per tenant are often subject to negotiation between the landlord and tenant, but can wind up being a significant additional rent expenditure.
The firm should consider not only the cost and allocation of parking spaces but also the location of the reserved parking and whether there is sufficient visitor parking either in (or under) the building or nearby.
SECURITY.
Because of the sensitive nature of the work that professional
services firms perform for their clients, the buildings in which they office must be secure. Building security can differ dramatically from one building to another; however, the firm should ascertain whether the office buildings under consideration provide protection, such as security guards, video cam-eras that monitor the common areas of the building and the parking garage, and access cards or keypad entry systems for the building’s tenants. Additionally, the firm should ask whether access to the building, both externally and internally, is restricted during nonbusiness hours. Often, during nonbusiness hours, tenants in a building are granted access to only the f loor or f loors on which they office.
RENTAL RATE AND EXPENSES.
Of all the foregoing issues that the firm
should assess on paper, perhaps the most important consideration is the price per square foot that the landlord is asking and what expenses the firm will be expected to pay. In almost all cases, commercial office space is quoted based on the price per square foot. However, this number can vary rather dramatically depending on the market. For example, in 2003 the average asking rent for a mix of Class A and B buildings in New York City was $47.02 per square. On the other hand, the average asking price for similar office space in Dallas was $20.35 per foot. Exhibit 18.1 shows the 2003 average price per square foot of Class A and Class B office space for 29 of the largest U.S.
markets. The exhibit also ref lects the 2003 vacancy rates in each market.
The vacancy rate can have a dramatic impact on both rental rates (an inverse relationship exists between rental rates and vacancy rates), as well as the landlord’s willingness to negotiate and give on certain terms of a lease. Although the asking price per square foot is negotiable and depends a great deal on the real estate market, it should be relatively simple for the firm to rule out alternatives that clearly fall outside the firm’s preliminary budget.
In addition to the price per square foot, the landlord will also seek to recover from the tenant a portion of the operating expenses associated with the leased premises. What is included in the definition of operating expenses depends on how that term is defined in the lease; however, in
U.S. OFFICE: YEAR-END 2003
VACANT SPACE
Y-T-D
QUOTED RENTAL RATES
MARKET
VACANT SF VAC %
NET ABSORP
CLASS A ($)
CLASS B ($)
1 Atlanta
38,212,470
17.4
488,847
20.96
16.19
2 Austin
11,003,756
18.7
467,487
19.56
17.12
3 Baltimore
12,265,346
14.6
511,516
21.44
17.83
4 Boston
41,914,373
14.9
(1,713,211)
25.52
18.84
5 Charlotte
8,316,639
14.3
115,031
19.54
16.01
6 Chicago
60,274,643
17.5
(2,084,261)
27.92
21.09
7 Cincinnati
9,568,033
15.0
(422,197)
18.57
15.15
8 Cleveland
14,599,859
16.7
(1,206,311)
20.96
18.03
9 Columbus
10,675,469
15.3
(224,831)
18.29
15.91
10 Dallas/Fort Worth
54,393,363
21.2
(1,321,402)
20.35
16.12
11 Denver
26,627,391
17.5
(333170)
19.56
15.84
12 Detroit
23,022,862
16.5
252,904
24.09
19.75
13 Houston
36,379,858
16.8
(1,562,424)
20.57
16.09
14 Jacksonville (Florida)
4,656,598
12.8
214,714
19.16
17.07
15 Los Angeles
47,088,090
12.8
3,627,294
25.67
22.11
16 Minneapolis*
11,995,159
23.1
(698,268)
19.48
17.75
17 New York City
49,894,973
10.3
809,767
47.02
32.53
18 Northern New Jersey
41,461,052
14.8
1,540,882
26.71
20.82
19 Orange County (CA)
15,261,193
12.2
3,872,769
24.56
22.31
20 Orlando
8,589,690
13.8
336,810
20.33
17.79
21 Philadelphia
40,568,678
15.9
(3,559,273)
23.47
18.52
22 Phoenix
17,166,985
15.9
3,250,136
22.15
19.35
23 Raleigh/Durham
7,805,438
17.5
595,488
18.76
15.89
24 San Diego
9,581,579
11.7
1,456,488
29.57
25.27
25 San Francisco Bay Area 55,327,833
17.4
491,690
26.54
22.97
26 Seattle/Puget Sound
16,936,507
13.3
1,190,471
24.53
19.65
27 South Florida
20,395,707
12.7
2,537,962
26.71
21.13
28 Tama/St. Petersburg
10,102,167
12.6
471,460
20.68
16.98
29 Washington
43,624,113
12.0
6,426,232
30.01
26.87
Class A, B, C
Class A
Class B
Exhibit 18.1
Recent Square-Foot Lease Rates in Major
U.S. Metro Areas. Source: CoStar Group. Inc. *NAIOP
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479
general, operating expenses refer to the actual costs associated with operating an office building, including maintenance, repairs, management, utilities, taxes, and insurance.
Operating expenses are dealt with by one of two different types of commercial leases, the gross lease and the net lease. According to one author, the difference between the gross lease and net lease can be explained as follows: The primary difference between these fundamental lease types is the variation in responsibility of the payment of operating expenses. At one end of the spectrum, the gross lease generally requires the landlord to pay all of the operating expenses. At the other end of the spectrum, a net lease generally provides that the tenant will pay a pro rata share, as defined in the lease, of all operating expense items.4
GROSS LEASES. Under a traditional gross lease, the tenant’s monthly rent will be higher than under a net lease because the landlord has assumed responsibility for all of the operating expenses. However, under a traditional gross lease, the landlord also assumes all of the risk that such operating expenses will increase during the term of the lease. Thus, it should come as no surprise that landlords today are rarely willing to enter into a traditional gross lease. Rather, landlords most often attempt to limit their exposure under a gross lease by inserting provisions in the lease that allow the landlord to offset the cost of any future increases in operating expenses. One way landlords might try to limit their exposure under a gross lease is to insert a provision that ties future increases in monthly rent to the Consumer Price Index (CPI).