Is Your Rent-to-Revenue Ratio on Target?

by | 04 March 2015

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

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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 percent in some industries to as high as 15 percent for some professional service organizations such as law firms.

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Here’s the logic behind utilizing this metric:

  • 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 where 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.

Coy Davidson is Senior Vice President of Colliers International in Houston. He publishes The Tenant Advisor blog.