Are You Paying Too Much for Office Space?

The Top Five (5) Metrics for Office Space

Given that occupancy costs are often the second largest expense for companies and organizations behind employee wages and benefits, real estate cost saving measures are a high priority for executives. These typically focus on reducing square footage while also reducing rental rates, operating expenses, and real estate taxes. This is especially the case in this millennial age of office space where companies and organizations are employing new methods of collaborative work environments and technology advances. However, how does an executive know what is the appropriate balance of office space densification and cost reduction while at the same time not jeopardizing employee morale, productivity, and culture?

Many office space projects begin with a space programming session with an architect and jump right into touring buildings without properly answering this question. Anyone can be a space finder; however, a skilled corporate real estate advisor will address this question before “kicking tires”. Here at Newmark Grubb Knight Frank, my business partner, Doug Damron, and I employ a strategic planning approach to every client’s real estate project. By partnering with our clients in a consultative manner, we are able to plan for both the short-term and long-term as well as provide flexibility in times of unforeseen circumstances.

We put special emphasis on benchmarking and diving deep into our client’s unique economic circumstances to determine the appropriate balance of cost savings measures. The below metrics vary greatly from industry to industry and organization to organization. For comparison purposes of the ratios, we put general low-end ranges that are typical of a non-profit or cost-conscious company. However, for law firms or other high cost/high revenue industries these would be much higher.

Nonetheless, these metrics are applicable to all industries and organization and include the following:

1. Occupancy Cost to Revenue Ratio

A debt-to-income ratio, similar to the “housing ratio” or “front-end ratio” for residential, this ratio looks at an organizations percentage of revenue that is going to occupancy costs. Landlords and lenders looks at this ratio when making decisions on security deposits and financing. However, we encourage our clients to look at this from an operational perspective when making decisions to increase or decrease the size and/or quality of office space.

Low Range – 3% to 5%

2. Occupancy Cost Per Square Foot

This can vary greatly from market to market based on rental rates (i.e. quality of building), operating expenses and real estate taxes.The average national rental rate in the U.S. is currently $29.98 per square foot with Columbia, SC at $16.97 per square foot on the low-end and San Francisco at $68.91 per square foot on the high-end.

3. Occupancy Cost Per Employee Ratio

Similar to occupancy cost per square foot, this ratio can vary greatly from market to market.However, it is important to understand what the “desk cost” is for each employee especially when making decisions to adjust open to closed office space, teleworking, and flexible work hours (e.g. hot desking and hoteling).

Low Range - $9,000 to $22,000 per employee

4. Square Footage Per Employee Ratio

This can vary greatly on an organization’s culture and demographics. For instance, is it a senior level organization with employees that expect closed offices or a millennial heavy organization that prefers open workspace? This number also takes into account each employee’s proportionate share of the common areas (reception, kitchen, workroom, conference room, etc.) as well as the difference between the useable square footage (tape measure) and rentable square footage (add-on factor for building common areas (lobby, bathrooms, hallways, etc.).

Low Range –200 to 250 square feet per employee

5. Average Annual Cost

Many office leases are long-term commitments (5, 7, or 10 years or longer) and are often front-loaded with incentives (e.g. free rent). These concessions make the earlier year’s annual costs substantially lower than mid or later years, especially when taking into account annual rent escalations. Therefore, it is important to average these across the lease term to determine the effective rent.

Similarly, owner/users of office condos and office buildings need to look at this from a long-term perspective as often maintenance is deferred and real estate taxes can increase dramatically from year-to-year.

Bottom Line

These metrics are valuable indicators in evaluating whether an organization is paying too much for office space.