Dec 3, 2014 9:07:00 AM

Understanding Your Lease Obligations

By Don Catalano


Commercial Real Estate Lease ObligationsAs you're reading this, teams of accountants all over the world are working on new ways to answer an age old question in the real estate world: are lease obligations debt or not? Because corporate real estate has historically existed in a separate category from traditional debt, many companies have failed to manage that expense as aggressively as other obligations. If your company falls into this camp, here are some of the questions that your CEO and CFO should be asking.

1) What do we owe?

While debt is calculated and reported on your company's balance sheet, lease obligations are treated differently. You might have a handle on your total annual expenditure, but leases typically span multiple years. In essence, they are no different from mortgages in that you agree to make a stream of monthly payments over a period spanning years.

Answering this question puts you in a position to start asking deeper ones. Those deeper ones go beyond tabulating dollars and cents and into calculating their impact on your organization.

2) How are we managing our lease obligations?

It is common for businesses to carefully look at their leases twice -- right when they get signed and right before they expire. While your lease obligations are frequently set in stone by the formal document, what you pay -- and what you get as a return on your investment -- is much more fluid. Occupancy costs shift due to rent increases or due to changing utility prices, insurance premiums and the like. At the same time, your relationship to your space changes with your business while your landlord's needs can shift based on the performance of his overall portfolio.

Moving to a more active management regime can improve your real estate performance. First, carefully reviewing expenses as they come in gives your team an opportunity to spot -- and fix -- discrepancies. Second, it allows you to see when spaces are becoming inappropriate long before the lease ends, letting you take action to reduce waste.

3) What is our KPI?

When measuring the return on your lease obligations, you need to have the right measurement tools in place. The most traditional tool is to look at occupancy cost per square foot. It is always wise to confirm that you're paying a reasonable rate for your space in your given market. However, beyond that, price per square foot is not a particularly useful KPI. After all, it is largely a given that space in New York will cost more than space in Huntsville.

Instead, turn to KPIs that look at utility and at impact. For instance, calculating your cost per employee lets you see how much use you get out of your dollar in terms of housing people. Customer-facing offices can be judged on the basis of their sales per square foot or by comparing their total rent to their total sales.

4) How are we reducing costs?

Finally, you have more control over your lease obligations that the documents imply. Just because you have nine years left on a 10 year lease for a newly vacant space does not mean that you have to absorb that expense. Your landlord might be willing to entertain a buyout, or you could sublease it to another tenant that pays some or all of your rent. Investing in new capital equipment to lower energy utilization is another way to lower costs. Getting outside help from a broker that can help you not just find space but also be a strategic partner in managing occupancy costs can also be helpful.


Articles you might be interested in:

5 "Gotchas" in Your Office Lease

The Benefits of Open Office Space

Protecting Yourself from Signing the Wrong Office Lease


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Topics: lease obligations, commercial leases, commercial lease obligations, Lease Management, corporate real estate, commercial real estate, tenant tips, CRE

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Don Catalano