How to Budget for Your NYC Office Space
You might have seen the Tribeca penthouse that was recently rented for $85,000 per month, making it the priciest rental in New York City history. All that money to blow on a 5,500 square foot triplex has us asking one question: how do we become friends with that guy?
Now that NYC is opening back up, the residential market is coming back in a big way (aka a classic New York love story: you can’t get an apartment). With the talented workforce here to stay, we’ll let you in on a little secret: the NYC office leasing market is already back, and companies are coming in hot. The city may not be booming the way it was pre-pandemic (yet), and there is still a 20% vacancy rate with close to 80 million available square feet on the market, but we’re seeing companies slowly but surely securing space to get back to the office.
With COVID-19 calling into question whether office space is a necessary expense, we’re now seeing an increased focus on what exactly it will cost to come back. Whether you’re reinventing your company’s footprint by taking a brand new, built-for-you direct space or snatching up one of the beautiful plug and play subleases left on the market, it’s important to understand what different space specifications and “must haves” will cost you, and how to budget for fully loaded space costs (hint: it’s not just rent). Here are two common questions we’re hearing in conversations with clients and other decision makers looking to bring employees back to the office and answering for you here:
1) What costs am I actually incurring when I take office space?
The most important (and well known) cost for any space option is base rent. This will differ based on “micro” factors like the neighborhood, building class and ownership, type of space, and how much money the landlord is putting into the build; and “macro” factors like the state of the market (hence the steep discounts from COVID-19). Base rents can range from $30s for a cheap, short term sublease to $150+ for new construction buildings, and will always be the dial mover of space budgets.
But space costs are not limited to base rent only; most NYC tenants understand this on a conceptual level, but we’re always fielding questions on how exactly to budget for the other space related cost items. First things first – it’s part of our job to model these costs for you alongside any space on which you submit an offer and receive a counteroffer. Our goal is to give you transparency and empower you to make the best decision for you and your bottom line; whether it’s us or another broker, your broker should always pair any offer or space negotiation with a corresponding financial analysis that shows you the closest possible estimate to what you’ll be paying on a monthly and annual basis, and where exactly those costs come from.
So where do those additional costs come from?
- Operating expenses paid as annual rent escalations – no matter what space you take, you’re going to pay annual rent escalations that start 12 months after the start of the lease. Annual rent escalations are typically used to cover the operating expenses of the building so there is no additional cost to the tenant for operating costs like gas, water, and sprinkler. Depending on the size and term of your deal, you will pay:
- direct operating expenses: your landlord will pass operating expenses directly through to you; this is typically given to tenants taking a large footprint or tenants taking a long term.
How to budget for this: we typically model this as a 1% annual increase in base rent.
- indirect operating expenses: in most cases, landlords will charge each tenant a market standard range of annual increases in base rent and keep the spread between what they pay for operating costs and what you as the tenant pay. This should be specified as a hard number in your lease.
How to budget for this: this is typically a 2% – 3% annual increase in base rent; we’ll model depending on which number is specified in an offer or term sheet.
- Real estate taxes – as a tenant, you’ll pay your proportionate share of the increase on your building’s real estate taxes above a base year. Your base year will typically be the year in which you’re signing the lease, and establishing this base year correctly can have a big dollar value impact.
For example: you are taking 5,000 square feet of space and the building is 500,000 square feet total, so your proportionate share of the building is 1%. In your base year of 2021, the building paid $5,000,000 in annual property taxes and is expected to pay $5,125,000 in 2022 and $5,300,000 in 2023. You will pay 1% of $125,000 (the difference between 2022 and 2021 building taxes) in 2022, and 1% of $300,000 in 2023 (the difference between 2023 and 2021). Your base year (2021) is always fixed; every year that follows is still based off of the base year, so when the taxes are $6,250,000 in 2027, you pay 1% of $1,250,000 (the difference between 2027 and 2021).
Note: nobody can predict taxes to the dollar so taxes in our financial analysis are always an estimated cost, but we’re able to estimate pretty closely by calculating a 5 year historical average based on the building taxes.
- Electric – this is your standard electric bill.
How to budget for this: we typically model this between $3 and $3.50 per square foot for “standard” usage.
- Commercial rent tax – If your annual rent is above $250k, you’ll pay a commercial rent tax to the city:
How to budget for this: this is calculated as 3.9% of total annual rent (not just the annual rent above a $250k floor – this is a common question we get).
- Operating expenses – The additional operating costs of a building, such as gas, water, and sprinkler, are typically baked into rent escalations (see (a)) , but this can vary depending on the building and owner. Some buildings will start with a lower base rent and use both annual escalations and additional operating expenses to land on par with the rest of the market; buildings that do this are typically not marketed as your typical full service “office” building, and your broker should know from experience whether you can expect to pay these charges in a specific building.
How to budget for this: buildings vary, but you can estimate that garbage removal will cost about $300 / month, and water and sprinkler will cost you around $200 / month. Again, this all varies depending on the size of the building, the amount of space you take, and the number of tenants in the building.
- Cleaning – Class A buildings include cleaning in their base rent – most others don’t. You will likely have to use the building’s vendors, but will pay for the service on a monthly basis.
How to budget for this: we model cleaning at an estimated $2 / sf annual cost if it’s not included in your rent.
- Security deposit – almost every tenant will pay a security deposit when they take a space. It will typically be in the form of a letter of credit for your bank, and depending on your size and stature you will or will not have to cash securitize that letter of credit. This is an important number to model from a budgeting perspective because it is a cost tenants are expected to pay upfront in year 1.
How to budget for this: for most tenants, we will model security at 5 months of rent; for companies with strong financials and established history, most landlords will ask for between 4 and 6 months. This varies depending on the history of your company, so startups are typically asked to post closer to 12-18 months worth of security, whereas a billion dollar publicly traded company may not need to post security at all.
All of the above costs are economic terms of a lease and will be negotiated by your broker. The amount you pay will always depend on the space you’re taking, but the above expenses can be found in essentially any lease. It’s important to remember all of these costs when creating a budget for a long term lease. It’s our job to help you navigate the budgeting process to see exactly where your money will be going within your space. One tactic we use to help our clients understand this process more fully is by creating a financial analysis that not only cost compares between different spaces, but also compares the offer we give to the counteroffer ownership sends back. This helps us to know what points are negotiable in the lease, and where we’re likely to land a deal.
Takeaway: the costs that you’re actually incurring when you take office space will include more than just base rent, but a good broker will be transparent and help you understand the full picture of what you’re paying for.
2) How should I think about “must haves” vs. “wants” in my space planning and budget?
Dreaming up your ideal office space is a bit like a kid in a candy store. It’s important to find (or have the landlord build) space that includes as many elements that you and your employees could possibly want, but within the budget that works for your bottom line. Each client is different when it comes to their specific space needs; some value building amenities like ample outdoor space or community lounges, or want a corner unit with the best views of the Manhattan skyline, while others just want an elevator to get them from point A to B.
When budgeting, it’s important to distinguish between space “wants” and space “must haves”, and oftentimes the compromise comes down to cost. Being as discerning as possible with yourself (and us) will help distinguish between spaces that work within your budget and spaces that fulfill every wish but aren’t worth the cost compromise. Most landlords in this market will “build to suit” within reason, meaning they will do a standard build for you with a mix of conference rooms and offices. Elements like internal staircases and other features outside of the standard build will likely be built by the landlord but paid for by the tenant. Deciding who pays for what is an important part of the negotiation process when the construction for your space involves an above-standard build.
In many cases, a sublease can be the best way to take steeply discounted (relative to a direct space) space that checks all the “must haves” AND the “wants” because another company has invested in upscale design and optics. They’re right, but in this market there’s a serious “flight to quality”, meaning the most beautiful, fully furnished, brand new built out spaces are competitively priced and are moving quickly.
Takeaway: it’s important for office space planning and budgeting to factor in “must have” vs. “wants” in a space, and understand what costs you will be responsible for.
The end goal in any space decision is that you as the tenant are happy with the space they’re in. We want you to be as educated as possible throughout the entire process so you can make reasonable and financially sound decisions and avoid any and all “gotchas” in the lease negotiation process. With a strong understanding of how to budget and what exactly you’re budgeting for, you’ll save money and feel at ease knowing where your money is going when signing on the dotted line. And don’t worry, you can invite your trusty commercial real estate brokers over for a congratulatory cocktail when you sign for your $85,000 penthouse in Tribeca, too.