More employees for the same size office space result in hidden costs.
In the workplace, the trend continues of smaller space for individuals and larger spaces for collaborative activities. Since the 1990s, companies have reduced the square footage allocated to each employee from 250 to 300 rentable square feet to today's low of 100 to 150 rsf.
As the cost of real estate rises, companies have more incentive to increase their headcount within the same sized office space. Furthermore, landlords are moving toward allocating more shared space in their buildings. These creative spaces have fewer private offices and larger open areas, allowing for dense workstation layout and boosting employee count even further.
A recent survey of landlords in the Orange County, California, and Los Angeles markets shows mixed results. Some landlords have capped occupants per square foot and tried to enforce those counts. Other landlords are caught in the quandary of being stuck with at least one tenant with an excessive number of employees. Other owners are not dealing with the problem.
The landlords who aren't concerned about this issue usually have lower occupancy buildings, so the parking remains plentiful and the low occupancy in the building doesn't feel like the offices and common areas are overcrowded. However, many of the brokers surveyed felt that once a building reaches 85 percent occupancy, this issue becomes problematic.
Landlords normally equate employee occupants in their suites with the parking allocation that is negotiated in the lease. However, many companies have far more employees than parking passes.
Parking challenges aside, recent experiences with companies that overload employees in an office suite reveal other concerns and costs for landlords. These include higher day porter costs due to numerous restroom cleanings, extra paper products, and stocking of supplies.
Office buildings are designed for a certain heat load on a floor. When a floor has six to 12 individuals per 1,000 rsf of space, the HVAC system is inadequate due to the resulting heat generated by computers, monitors, equipment, and people.
Building HVAC systems often are modified since the building engineer must reconfigure air flow to accommodate the excessive heat load in a certain suite or floor. Operating equipment above normal capacity increases repair and maintenance costs. More importantly, it decreases the useful life of HVAC systems.
Undue wear and tear on the elevators from the increased personnel riding up and down is hard to quantify, but still causes a high cost to the building owner with excessive repairs and reduced lifespan. Current generation elevators have a 15- to 20-year lifespan, so replacing them a few years early is extremely costly.
Excessive people in a suite or on a floor changes the culture and tone of the building. Often, tenants that employ six to 12 people per 1,000 rsf are hiring from a different labor market. This affects the Class A feel that the other companies in the building are paying for, thus jeopardizing future lease renewals.
While multifamily rental agreements address how to handle additional occupants in an apartment, office leases usually have not addressed this problem. All this raises the question: How can building owners be compensated fairly for excessive body count in their office spaces?
Research shows that only a few U.S. landlords have occupancy caps, and none have calculated compensatory schemes or default language in their leases for extra tenants occupying a suite.
How is this trend of more occupants in the same space affecting owners' costs? What equitable solution exists for both landlords and tenants? While a lease negotiation often includes a major deal point relating to parking stalls per 1,000 rsf, only in a few cases does a landlord address maximizing the headcount within a suite to about five or six per 1,000 rsf.
As a result, a tenant can squeeze in as many employees as possible, provided proper fire department guidelines are met. If the lease allows it, the building owners are forced to accept the situation.
Furthermore, the landlord must figure out how to keep the space cool enough in the summer and the bathrooms clean and stocked, as well as reduce the wear and tear in the common areas. This is costly and detrimental to the rest of the building's systems and other tenants.
In the rare lease where a headcount cap is specified, a violation of such cap is treated like any other breach of the lease terms. Attaching a monetary penalty to such violation presents legal issues. Even if it is structured as a liquidated damages provision, this clause may not be suitable. The owner may not want more occupants to alter the professional environment of the property, even if the tenant pays more rent.
This dilemma prompts two points of resolution for the owner.
- How to limit the occupancy; and
- Upon request of a tenant to be permitted more occupants, whether to allow it.
If the provision is included, how does an owner establish sufficient extra rent to compensate for the higher costs? Limiting occupancy can be accomplished through including appropriate lease language. In those circumstances where the landlord is amenable to allowing more occupants, devising an acceptable added rent charge is the challenge.
A spreadsheet of the building's size, operating expenses, and total occupancy can analyze a building's operating costs and help to determine a cost relating to each additional occupant. Start with an assumption of five people per 1,000 rsf for a hypothetical 200,000 rsf Class A office building in Orange County, California.
Look at three perspectives of operating costs through which to filter the results. Method 1 views gross expenses from the landlord's perspective. Method 2 considers variable expenses per the owner. Method 3 evaluates the rent from the tenant's perspective.
Method 1 encompasses all the costs of operating the building and providing rental space to the market. This calculation takes all the common area maintenance operating costs and calculates the amount to operate the building fully leased with five people per 1,000 rsf occupying the building. In this example, this yields a cost per person per month; at $10 psf per year in total CAM, the cost per person is about $.016 psf per month.
Method 2 analyzes the landlord's variable expenses for occupancy. For example, landscaping costs remain static whether the building is empty or full, while janitorial expenses increase proportionally with the number of tenants. In the example by netting out the fixed costs, the variable costs reflect one person consuming only $.0043 psf per month.
Method 3 looks at costs per employee through the tenant's eyes by calculating the monthly rent and dividing it by the number of employees. For instance, a tenant with 10,000 rsf at $2 psf could be allowed a maximum of 50 people per 1,000 rsf as specified in the lease. The cost is $400 per month per person, equaling $.04 psf per month per person.
By averaging the results of these three methods with a 20 percent mark up to cover ownership return on investment, debt service costs, and reduced useful life of HVAC and elevators, the average was $.024 psf per month for each person in the building.
The assumption is five individuals per 1,000 rsf in a fully occupied building. This average of $.024 psf per month represents about 50 percent of what the tenant is paying for each of its employees, as noted above in Method 3 of $.04 psf per month.
After evaluating the return on costs for an owner, total operating expenses, and adjusted operating expenses, this example shows that a tenant should pay 50 percent more in rent for extra employees above the established body count cap. Of course, each building operates differently, so the calculations may vary a bit. Billing specific tenants for excess occupants allows the owner to lower its CAM charges to other tenants in the office building. Increased variable expenses offset the reduction in total annual operating expenses and base years.
Just as an owner reduces the electricity expense when separate meters are installed for HVAC units to cool server rooms in tenants' spaces and charged back to the individual companies, so are higher costs for tenants with extra employees given to compensate owners. This will keep true operating expenses lower, which boosts net operating income and value.
Below is an example of a provision to the lease that covers the cost of excessive employees working in a limited office space.
Premises occupancy. Tenant acknowledges that the number of persons present in the building and at the project has a direct relationship to costs incurred by the landlord. Excessive occupancy results in costs and burdens not contemplated at the rental rate negotiated hereunder, and additionally can have a negative impact on the professional office environment sought to be maintained by landlord.
Tenant agrees, therefore, it shall not exceed a maximum (further subject to applicable fire agency or city regulations that may be more restrictive) of five permanent occupants per 1,000 rentable square feet leased, (the occupancy cap), without prior written authorization from the landlord, which the landlord may withhold in its sole and absolute discretion. For purposes of this paragraph, permanent occupants are defined as the tenant and its employees or contractors performing services within the premises at any one time within the leased premises, or in the event the tenant conducts training of nonemployees or contractors regularly, three or more days per week, such additional persons shall be included in the definition of permanent occupants.
The tenant may, with the landlord's approval, and at the landlord's sole discretion, add additional permanent occupants to the premises that exceed five persons per 1,000 rsf at a cost of 50 percent of its then current monthly base rental amount divided by the square footage of the premises per occupant.
For example, a $2 psf monthly rental rate for a 10,000 rsf space equals $20,000 per month. Divided by 50 maximum occupants at five individuals per 1,000 rsf equals $400 per month. Fifty percent of $400 is $200 per month per additional permanent occupant, or $.02 psf.
Violation of this covenant shall be a material breach of this lease, and entitle the landlord to pursue all remedies for breach of lease and unlawful detainer. A violation of this covenant more than three times in any 12-month period shall be a noncurable default in the lease terms, and the landlord may thereafter terminate the tenant's right to occupancy.
Per the brokers surveyed, capping occupants is becoming part of the negotiations, as companies strive for more efficient office space. Clearly stating how to monitor and define tenant occupants is critical, as shared workstations, hoteling, and telecommuting become more prevalent. To ensure lease compliance, work with the tenant to understand the schedules of its employees and consultants, and count workstations to clearly define the expectations within the terms of the lease.
While it will take time to add an occupancy cap for all tenants in an owner's building, this is recommended as new leases are negotiated. While landlords may worry about tenants' response to being charged for extra employees, in reality it has become another clause in the lease. Also, incumbent tenants welcome the news that new tenants cannot exceed the norm of five employees per 1,000 rsf.
By building this clause into the lease during the negotiation, the tenant knows that occupancy is limited and predetermines how to handle this situation. Without a methodology to manage this, the result could be lease default and eviction.
But landlords need a tenant's rent. Furthermore, many states' courts wouldn't enforce an eviction simply because a tenant exceeded its occupant count by one person. Should a tenant need to expand for accommodating growth, the tenant can lease more space in the building at the full market rental rate.
Alternatively, by using the appropriate calculations and considerations, the landlord can make a determination whether to allow additional permanent occupants. As described and calculated, the payment of more rent for higher occupancy is a bargain for the tenant.
Establishing an occupancy cap helps to preserve the quality of the office building environment and justify a reasonable rent for the number of occupants. Addressing this issue directly in the lease negotiations provides better tenant relations, avoids potential confrontations, and generates more income for the building owner.