Avoid ‘loss factor’ leasing headaches
An important part of my job as a commercial real estate broker is to find potential problems as early as possible. I've found that the earlier a problem is identified, the more likely a reasonable solution can be implemented.
In commercial leasing, one area I have learned to focus on is the concept of “loss factor.” Simply put, a commercial building's loss factor is any area that is shared with other tenants but still paid for via rent. This results in a difference between a commercial property's usable square footage and its rentable square footage. Shared space includes, but is not limited to, common hallways, stairwells, elevators, lobbies, mechanical rooms, data closets and, in some cases, outdoor space. The shared space is considered “lost” because, while it is not exclusively usable, it still needs to be accounted for and ultimately subsidized by the usable areas.
Regardless of how you calculate a property's loss factor, it is the simple fact that there are two different definitions of square footage that frustrate and confuse tenants: usable versus rentable.
Several years ago, I was representing an office user in a relatively straight-forward lease transaction. We found a very nice office suite for his business in a multi-tenanted property in downtown Portland that was being marketed as 3,000 square feet. But when he did a thorough measurement of each room, interior wall to interior wall, he only came up with about 2,700 square feet.
He was not happy. He curtly clarified to me that 2,700 does not equal 3,000 and that we had a major problem. I was able to explain loss factor to him, and he begrudgingly accepted the concept. But the lesson was learned; I would never again assume all businesspeople, even those with real estate experience, understood this important concept.
It is reasonable to ask what the loss factor percentage is when searching for commercial space. In the example above, where the “usable” square footage is 2,700 and the “rentable” square footage is 3,000, a difference of 300 square feet, the loss factor is a relatively low 10%. I would say that any loss factor under 15% is consistent with the market. If you see anything higher than that, some tough questions to your landlord might be warranted. There are a lot of inefficient buildings out there, particularly older office towers. If there are huge lobby areas, or several mechanical rooms on each floor, you might be shocked at the discrepancy between what you are paying for and what you are actually using.
Another real life example I recently encountered was with a retailer client. She had been renting the same space for over 15 years and was considering a move. As part of her diligence, I suggested we negotiate with her current landlord to find out the renewal cost. I further suggested she get the space measured. We were shocked to find that she was paying for space with a surprisingly high loss factor. This was unusual because her access was directly off the street and there was literally no shared space beyond the mechanical rooms in the building. It turned out the landlord was charging her the same loss factor as his upper floor office tenants. Needless to say, that did not go over well and the decision to move was that much easier.
The best way to avoid problems, as always, is clear and concise communication at the beginning of a negotiation. Oftentimes, this is done through a letter of intent that leads to a lease. When drafting an offer, the amount of square footage you are renting is always included. But it is not always specifically noted whether it is the usable or rentable amount.
This is an oversight that is easily avoidable. In some cases, it is fair to ask a landlord to professionally measure a space in accordance with “Building Owner and Managers Association” standards prior to lease execution. This is a third-party definition of what qualifies as “common space” and how your square footage should be calculated.
Steps like these can avoid uncomfortable and costly arguments in the future.
Justin Lamontagne, a commercial broker with NAI Dunham Group, can be reached at justin@dunham-group.com
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