In today’s challenging economic climate, it is crucial for property owners to maximize their returns and safeguard their cash flow. We are consistently having these conversations – owners are facing difficulties in filling vacancies, borrowing costs are skyrocketing during refinancing, and every expense on the sheet is rising each year due to inflation. Consequently, owners are witnessing a sharp decrease in their cash flow and property value.
Often, we see owners overlook their operating expenses when their tenants are on a triple-net (NNN) lease structure. In NNN leases, the operating expenses, commonly including property taxes, insurance, and common area maintenance, are passed through to the tenants for reimbursement to the owner. With most operating expenses covered by tenants, owners are not directly impacted by increases in expenses unless they have a vacancy.
Looking at this through the lens of the tenant, higher operating expenses put a strain on their business’s profitability, making them a less stable tenant. Through the owner’s lens, a less stable tenant can affect rent collection, ability to increase rents and lowers your probability of future lease renewal.
We advise owners to consider reducing a tenant’s occupancy cost, which can enhance their business, boosting their chances of a lease renewal. Additionally, it can assist in the leasing of vacancies and provides owners the ability to increase rents.
What does total occupancy cost mean?
In triple-net leases (NNN), there is base rent which is the contract rent per your lease then there are triple-net expenses (operating expenses) which are calculated on the tenant’s pro rata share of a building/center. These charges are treated as additional rent which then get added on top of the base rent. The two numbers combined are what we refer to as a tenant’s total occupancy cost. For example, if a tenant’s base rent is $1.00 PSF and their NNN monthly charges are $0.75, their total occupancy cost is $1.75. Occupancy costs are imperative for owners to understand to stay competitive in the market.
1. Property Taxes – Property taxes are usually the largest expense for an owner as they are calculated on what your property’s “assessed value”, and gradually increases annually. During shifts in the real estate market, it’s not uncommon to see owners paying property taxes on an assessed value that is greater than what the property is currently worth in the market. In some cases, these owners have been able to lower their taxes by filing a tax assessment appeal through their local county and providing evidence supporting their claim. More information on this can be found through your local county assessors’ office.
2. Installing Trash Compactors – Trash pickups can be a significant expense for owners with high trash users in their building. Increased trash usage leads to more frequent pickups by waste companies, resulting in higher costs. Trash compactors are a great way to optimize bin storage and minimize the need for frequent pickups. We know some owners in the market who have installed trash compactors for each tenant as a way to significantly reduce their expenses, in some cases cutting their bill in half. We have also observed owners who have chosen to rent them out to their tenants, thereby generating additional income.
3. LED Light Conversions – LED Light Conversions have become increasingly popular among owners looking to combat rising electricity costs. By switching their building, parking lot, and common area lighting to LED, they have reduced their utility bills considerably. Some owners have been able to reduce their annual bill by as much as 70%. In addition, LED lights offer a significantly longer lifespan compared to traditional incandescent, halogen, and fluorescent lights, reducing the need for frequent replacements.
4. Installing Water Submeters – Installing water submeters allows owners to track the water consumption of individual tenants. This motivates tenants to be more conscious of their water usage as they are held accountable for their consumption expenses. This can result in substantial decreases in total water consumption, which can help reduce utility costs for the property. Additionally, it promotes sustainability, benefiting both the owner and tenants.
5. Bidding Out Property Insurance – Insurance costs in California have seen significant increases due to many carriers exiting the state. Additionally, certain carriers are choosing not to renew policies upon expiration for buildings they have previously insured for an extended period. It’s crucial to prioritize bidding out your insurance in this current environment. Collaborating with an insurance broker can offer the advantage of accessing multiple quotes and receiving valuable recommendations to enhance the building’s appeal to carriers.
Consult with an Investment Professional
Working with a knowledgeable investment specialist who understands the market will maximize the benefits of your property and safeguard your cash flow. With our extensive resources and data insights, we have successfully assisted property owners in gaining a comprehensive understanding of their property’s performance relative to the market. This enables them to develop a strategic action plan to stay ahead of the ever-changing market trends. If you would like us to evaluate your property or gather more information about the market, please find my contact details below.
John Kourafas, CCIM, is a Commercial Investment Advisor with the Visintainer Group in Fresno, CA. Formed in 2018 and built on a foundation of investment real estate, the Visintainer Group is a client-first commercial real estate firm. The Group has executed over $825 million in transactions across the United States. John specializes in commercial property acquisitions and dispositions for owners in the Central Valley, Sacramento, and Central Coast markets. He can be reached at 559.890.0419 or [email protected].