Is Your Rent-to-Revenue Ratio on Target?

by CoyDavidson on December 23, 2011

Better Metrics, Better Decision Making for CRE

Most companies use a few basic metrics when comparing various office locations from a transactional standpoint or attempting to benchmark the performance of various operating properties across their real estate portfolio. The three most utilized measures are:

  1. Cost per square foot
  2. Square feet per person
  3. Occupancy cost per person

The Rent to Revenue Ratio

Today, a measure that is becoming increasingly utilized by many corporate real estate executives and savvy service providers is the rent-to-revenue ratio. Most industries, geographic regions and local economies have benchmarked rent-to-revenue ratios, or in simple terms the percentage of sales that you should be allocating toward property that is typical for your specific industry. Standard rent-to-revenue ratios can vary from as little as 2% in some industries to as high as 15% for some professional service organizations such as law firms.

The logic behind utilizing this metric is:

  • Enhance the ability to make strategic decisions about the appropriate level of investment in your workspace for various locations.
  • If a particular location or workspace strategy justifies the higher expense associated with it, it will clearly be evident in the increase in revenue generation associated with that decision.

Historically companies have always focused the spotlight on projecting the cost side of the equation when making real estate decisions particularly from a transactional standpoint.  Business decisions are sometimes made whereby the full implications of the real estate component are not given primary consideration. In an expanding economy where most companies are experiencing solid revenue growth there is a larger margin for error when occupancy costs are not aligned properly with revenue levels, and it’s not until there is a negative disruption in revenue that the implication of the decision become painful.

More and more emphasis is being placed on expenses as a percent of revenue as companies increasingly look at corporate real estate as a tool to gain a competitive advantage. Calculating rent to revenue ratios shifts the spotlight beyond just occupancy costs to the bottom line and will serve as a tool for better real estate decisions.

  • mikey

    Coy, this is valuable information that can set an agent/broker apart from the competetion. Thank You!

  • Barry Zoob

    This is not a new concept at all. When I graduated business school in 1969, occupancy cost ratios were very much in vogue, especially in retail but also throughout business. As an example, occupancy costs in the women’s retail business were 4% in the 70’s; today they are much higher due to percentage rent accelerators.

  • http://www.coydavidson.com/ Coy Davidson

    Yes I agree the location centric retail user has been using this concept for a long time.

  • http://twitter.com/NicholasKatz Nicholas Katz

    Coy, what about for a hospitality operation?

  • http://twitter.com/NicholasKatz Nicholas Katz

    As in, what would you expect a hotel/hostel operation to pay in terms of rent?

    Hotel, office, or anything else…what about the methodology for devising the amount of rent in a propco/opco model?

  • http://www.coydavidson.com/ Coy Davidson

    Nicholas, I really could not tell you about a hotel as it is not my area of expertise. My expertise is office and light industrial, but you can go to a site like http://www.BizMiner.com to get data on standards for specific industries.

  • Pingback: Corporate Real Estate Veteran To Younger Brokers: Ditch The Spreadsheets | Walter Unger CCIM()

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