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How to Set Rent Rates for Your Commercial Property in 2023
Setting your commercial property's listing rates based on several key data points ensures your space is competitive and you earn a healthy return.
Setting rental rates for a commercial property requires a data-driven approach. This approach involves analyzing various data points to ensure that the leasing rates are competitive, profitable, and in line with the market.
Deciding on your leasing rates for a commercial property is important — arguably more so than setting rates for multifamily assets. With office, retail, and industrial properties, lease contracts span multiple years — meaning if you underprice your space, you may have to live with the effects for years.
In this article, I will outline five essential data points I use in setting commercial real estate listing rates, whether it’s an office building, a warehouse, a retail unit, or even self storage. Along the way, I’ll use a real-world example — a 5,000-square-foot retail space — to illustrate how to use each.
Our Example Property
Before we get into each factor, let’s set up our example property.
Our retail property is located in a busy shopping district with high foot traffic. The building has a total leasable area of 5,000 square feet and is configured with an open floor plan, one bathroom, and two storage rooms.
The property has been recently renovated, and it has a new HVAC system, roof, and flooring. The total operating expenses for the property, including property taxes, insurance, maintenance, and management fees, are $30,000 per year. The mortgage payment for the property is $60,000 per year.
5 Factors to Use in Setting Rental Rates
1. Location and Market Analysis
One of the most critical factors in setting rental rates is the location of the property. The location of the property plays a significant role in determining its market value. Therefore, it's essential to analyze the location's demographics, population growth, and economic trends to assist in determining your rental rates. To do this, you can utilize data sources such as the U.S. Census Bureau, Bureau of Economic Analysis, and Bureau of Labor Statistics, to name a few.
Most importantly, you can also look at comparable properties in the area to determine their rental rates. This is where market analysis comes into play. Analyzing the rental rates of comparable properties can help you determine the market demand, which in turn can help you set the right rental rate for your property.
For our example property, we do some research — maybe even call a couple of brokers — and determine that the average retail listing price for properties in our market is around $30 per square foot per year.
2. Property Size and Configuration
Another essential data point to consider when setting rental rates is the size and configuration of the property. This can significantly affect what rates you can achieve, as larger properties tend to have higher rental rates than smaller properties. The configuration of the property also plays a role, as properties with more desirable features such as additional storage, better parking, or other amenities may command higher rental rates.
Let’s say we examine properties with similar, single-tenant open-plan layouts in our market. We find that these generally list for $27 to $28 per square foot.
3. Operating Expenses and Capital Improvements
It's essential to consider the operating expenses and capital improvements when setting the rental rate. Operating expenses include items such as property taxes, insurance, maintenance costs, and management fees. Capital improvements include any significant upgrades or renovations made to the property, such as a new roof, HVAC system, or flooring.
To determine the right rental rate, you should consider the operating expenses and capital improvements and add them to the property's mortgage payment to determine the total cost of ownership. You can then use this figure to set the rental rate that will cover these costs while generating a profit.
Remember the costs for our retail property: $30,000 for operating expenses and $60,000 for debt service. That’s $90,000 per year. Divide it by the square footage of the property:
$90,000 ÷ 5,000 square feet = $18 per square foot
That means we need an absolute minimum of $18 per square foot to break even. It should go without saying, but never set your rent rates at the break-even point. Your costs will increase over time, but that rental rate may be harder to adjust. You’ll need to add a healthy margin on top so you can set cash aside for reserves and hedge against inflation and rising interest rates, especially if you haven't secured fixed-rate financing.
4. Tenant Demands
Another critical data point to consider when setting rental rates is tenant demand. Tenant demands include the type of tenant that the property attracts and what the tenant is looking for in a property. For example, office tenants may be looking for a particular layout or access to specific amenities, while retail tenants may require high traffic areas or proximity to other businesses.
To determine the right rental rate, you should consider the tenant demands and ensure that your property meets their needs. This can help you set the right rental rate that will attract the right tenants and generate a steady income.
Our retail property does well here. Remember that it’s located in a busy shopping district with a lot of foot traffic. That means we should be able to command at least a small premium with our leasing rates.
5. Historical Rental Rates
Finally, it's essential to consider the historical rental rates when setting rental rates. Historical rental rates can provide valuable insights into market trends and changes that may impact the rental rates. Analyzing historical rental rates can also help you determine how the rental rates have changed over time, which can help you forecast future trends and adjust the rental rates accordingly.
For our example, we see that our metro’s rates for retail space have been holding steady, and most reports project rates should only slightly increase in the future in the next few quarters.
So: How Much Do We Charge?
Let’s review the data. Our market commands $30 per square foot on average — but remember, larger spaces tend to command more in rent, so we may not quite be there.
Similar properties with similar layouts are getting $28 per square foot at present. That’s a good figure to keep in mind — it’s highly relevant.
We also know that if we charge $18 per square foot, we won’t make any money. So, realistically we could use a bit higher of a figure as a floor — perhaps $23 or $24 to be safe.
Given our property was recently renovated and is located in a great area, we should be able to lease it for a bit higher than that, though.
In this example, charging around the $28 figure should be a safe bet, though if we need to fill the space quickly, $25 or $26 per square foot could attract more tenant interest.
However, if you're in a hurry, consider instead offering rental concessions instead of underpricing your rents. A concession (like a discount on the first month's rent, or a higher tenant improvement allowance) is typically a one-time thing that will impact your property's profits far less than lowering the actual rental rates.
In conclusion, setting rental rates requires a data-driven approach that considers several factors. Analyzing location and market demand, property size and configuration, operating expenses and capital improvements, tenant demands, and historical rental rates can help you set the right rental rate for your property.
As a commercial real estate investor, it's important to remember that setting rental rates is not a one-time event. Rental rates should be reviewed every time you need to lease space, adjusted based on prevailing market conditions. By continuously analyzing and adjusting rental rates, you can ensure that your property remains competitive and profitable in the long term.
Additionally, it's essential to keep in mind that rental rates are just one part of the equation when it comes to commercial real estate investment. Other factors such as vacancy rates, tenant retention, and market trends should also be considered when making investment decisions.
In summary, setting rental rates is a crucial part of commercial real estate investment, and it requires a data-driven approach. By analyzing location and market demand, property size and configuration, operating expenses and capital improvements, tenant demands, and historical rental rates, you can set the right rental rate that will attract the right tenants and generate a steady income. It's important to remember that rental rates should be periodically reviewed and adjusted based on market conditions and other factors, to ensure that your property remains competitive and profitable in the long term.