How to Calculate Commercial Rent

Commercial and retail leases use various rental pricing methods and this often creates a lot of confusion as it seems various articles contradict others. The decision as to which commercial lease calculation method to use is frequently related to the type of tenant business. It could also have to do with the economy, balancing a need to retain an occupant with their ability to pay based on their business revenues. Retail business revenues can vary significantly in a given year, whether from seasonal or just demand cycles so they would be treated differently than industrial warehousing.

Some leases work well for varying income, allowing the tenant to pay lower lease payments during lower revenue periods.

At this time in Kelowna commercial leases often provide a much better return than residential lease property. Investors with only residential single-family rental property experience often hesitate to get into commercial leasing, as it is more complicated. It can be well worth the extra education, however and I am always happy to answer questions.

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Commercial tenants are generally more business-oriented and experienced in leases. If not, they often hire real estate professionals or attorneys to handle their lease activities. This allows the math to be the number one driver of the industry as commercial location is based more on traffic requirements then love of the building.

Commercial rental properties include shopping malls, professional offices, strip centers, and free-standing buildings used for offices, hotels and retail space. Successful businesses are reluctant to change location unless more space is needed. Capturing a good tenant in an office or retail space can mean years of dependable rental income and positive cash flow for an investor. This is especially true if space is located in a high traffic area supporting a steady flow of business. The tenant will be reluctant to move when they aren't sure they'll maintain the level of business they enjoy in their current space.

Depending on the type of lease, the tenant often pays for repairs and improvements.

They take care of the property, as they have customers on site. They want them to have a pleasant experience so they'll return. There are very different lease types, and they often are based on the type of tenant business. Let's look at these lease types, how they work, and how they're calculated.

Rent Per Square Foot

Rent is set at $X per square foot of the leased space. This can be expressed either as an annual or a monthly amount.

  • Example with annual quote: A 2,500 square foot office space is quoted a rent of $11.50 per square foot. 2,200 X $11.50 = $28,750 per year for rent.
  • Example, same building and rent for monthly amount: 2,500 X $11.50 = $28,750. Divide by 12 months to get a monthly rental amount of $2,395.83.
  • Percentage Lease

    Retail volume can vary significantly due to many factors, including the economy and also location. For this reason, it is a common practice for a landlord, in their commercial lease calculation, to determine a base rent that they absolutely need, and then to have the tenant pay a percentage of their retail gross income in addition to the base rate. This is logical because, if the location is a good one, retail sales should rise and enable the tenant's ability to pay higher rent. This also creates a more attractive lease for the retailer as they only pay more if they are successful. There are two ways in which the percentage is normally calculated:

    1 . Minimum base rent + percentage over a certain base amount: In this case, the tenant pays a minimum base monthly rent, and then adds a percentage of all gross receipts over a certain base amount. Example: $2,000 per month base rent, and 5% of all gross receipts over $50,000 per month. Using one month's gross receipts of $72,000, we do the calculation this way:

    $72,000 - $50,000 = $22,000

    $22,000 x .05 = $1,100

    $1,100 + base of $2,000 = month's rent of $3,100

    2. Minimum base rent + percentage of all gross receipts: Here, we don't set a bottom line revenue before the percentage kicks in. Rent is paid on all gross receipts from zero. Example: $1500 base rent + 2% of gross business receipts. If we use the previous numbers, we'd take 2% of the entire $72,000 and add that to the base rent, as here:

    $72,000 X .02 = $1,440

    $1,440 + $1500 = monthly rent of $2,940

    The negotiation of rent for a commercial space can get quite complicated. This is why we are full time commercial realtors as we connect and clarify. Often the prospective business tenant knows their costs of doing business and anticipated revenues but do not know that specific area for market assessment. We tie all the critical information together.

    It’s a balance between both parties. Buyers will want to fit rent into their costs such that they can count on a certain level of profit. The property owner knows their cost of ownership and want to make a profit. Negotiated properly it’s a win-win is the usual result in commercial lease negotiations.

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