Commercial Investment Real Estate March/April 2018 | Page 34

This dilemma prompts two points of resolution for the
owner.
1. How to limit the occupancy; and
2. Upon request of a tenant to be permitted more occu-
pants, whether to allow it.
If the provision is included, how does an owner estab-
lish sufficient extra rent to compensate for the higher costs?
Limiting occupancy can be accomplished through including
appropriate lease language. In those circumstances where
the landlord is amenable to allowing more occupants, devis-
ing an acceptable added rent charge is the challenge.
Devising Solutions
Research shows that only a few U.S. landlords have
occupancy caps, and none have calculated compensatory
schemes or default language in their leases for extra ten-
ants occupying a suite.
How is this trend of more occupants in the same space
affecting owners’ costs? What equitable solution exists
for both landlords and tenants? While a lease negotiation
often includes a major deal point relating to parking stalls
per 1,000 rsf, only in a few cases does a landlord address
maximizing the headcount within a suite to about five or
six per 1,000 rsf.
As a result, a tenant can squeeze in as many employees
as possible, provided proper fire department guidelines are
met. If the lease allows it, the building owners are forced
to accept the situation.
Furthermore, the landlord must figure out how to keep
the space cool enough in the summer and the bathrooms
clean and stocked, as well as reduce the wear and tear in the
common areas. This is costly and detrimental to the rest of
the building’s systems and other tenants.
In the rare lease where a headcount cap is specified, a viola-
tion of such cap is treated like any other breach of the lease
terms. Attaching a monetary penalty to such violation pres-
ents legal issues. Even if it is structured as a liquidated dam-
ages provision, this clause may not be suitable. The owner
may not want more occupants to alter the professional envi-
ronment of the property, even if the tenant pays more rent.
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March | April 2018
Quantifying Costs
A spreadsheet of the building’s size, operating expenses,
and total occupancy can analyze a building’s operating costs
and help to determine a cost relating to each additional
occupant. Start with an assumption of five people per 1,000
rsf for a hypothetical 200,000 rsf Class A office building in
Orange County, California.
Look at three perspectives of operating costs through
which to filter the results. Method 1 views gross expenses
from the landlord’s perspective. Method 2 considers variable
expenses per the owner. Method 3 evaluates the rent from
the tenant’s perspective.
Method 1 encompasses all the costs of operating the
building and providing rental space to the market. This
calculation takes all the common area maintenance operat-
ing costs and calculates the amount to operate the building
fully leased with five people per 1,000 rsf occupying the
building. In this example, this yields a cost per person per
month; at $10 psf per year in total CAM, the cost per person
is about $.016 psf per month.
Method 2 analyzes the landlord’s variable expenses for
occupancy. For example, landscaping costs remain static
whether the building is empty or full, while janitorial expenses
increase proportionally with the number of tenants. In the
example by netting out the fixed costs, the variable costs
reflect one person consuming only $.0043 psf per month.
Method 3 looks at costs per employee through the tenant’s
eyes by calculating the monthly rent and dividing it by the
number of employees. For instance, a tenant with 10,000 rsf
at $2 psf could be allowed a maximum of 50 people per 1,000
rsf as specified in the lease. The cost is $400 per month per
person, equaling $.04 psf per month per person.
By averaging the results of these three methods with a
20 percent mark up to cover ownership return on invest-
ment, debt service costs, and reduced useful life of HVAC
and elevators, the average was $.024 psf per month for each
person in the building.
The assumption is five individuals per 1,000 rsf in a fully
occupied building. This average of $.024 psf per month
represents about 50 percent of what the tenant is paying for
COMMERCIAL INVESTMENT REAL ESTATE
Excessive people in a suite or on a floor changes the cul-
ture and tone of the building. Often, tenants that employ
six to 12 people per 1,000 rsf are hiring from a different
labor market. This affects the Class A feel that the other
companies in the building are paying for, thus jeopardizing
future lease renewals.
While multifamily rental agreements address how to
handle additional occupants in an apartment, office leases
usually have not addressed this problem. All this raises the
question: How can building owners be compensated fairly
for excessive body count in their office spaces?