Office Leasing: What Is a Remaining Lease Obligation?

Gregg Cohen Office Leasing Specialist Remaining Lease Obligation

Every company should do a Remaining Lease Obligation to best understand their real estate exposure. This is a key step in the office leasing process.

You’d be surprised to learn that you are paying more for your office space than you think! And there’s a simple way to find out what you are paying. It’s by doing a RLO, or Remaining Lease Obligation. This an analysis that helps you understand your numbers and your real estate expense exposure. I can’t tell you how many times I meet with a client, and I ask the question, “What are you paying for your real estate?” and they say, “I’m paying X dollars per square foot.” But, when I start asking more and more questions, it turns out those numbers are a lot higher than they initially thought.

With that in mind I want to talk today about the things that you need to be thinking about outside of the base rent. I find that tenants remember the base rent number from the initial lease, but they don’t think about all the other things. So, what are all of the other things? First, there are escalations, either percentage increase or direct operating, but either way, every year, you are responsible for paying for increases in the operating expenses of the building.

Let’s just take as an example, you sign a lease for $50 a square foot, 3% escalation. I would never let you sign a lease for 3% per annum, but let’s just go for 3% for the number. So, that’s $1.50 every year per square foot that that increases. So $1.50 over 10 years, that’s $15, and that’s not even including the fact that the number actually compounds each year which means it’s even higher. So right there, that $50 lease that was signed in year 10 is really $65 a square foot (even more).

Now, in addition to the operating expenses, you’ve also got to think about real estate taxes. Real estate taxes are based upon the income of the building. If for example, the annual increases in real estate are somewhere between like 40 to 50 cents. This is just a rough number for this exercise. The important thing is to note that it increases most years. So it goes, let’s say 40 cents a square foot to 80 cents to $1.20, to $1.60, $2, so on and so forth. So really, after 10 years, you could be paying somewhere between $3.50 or $4 a square foot. If you look at it, and you just take just the operating expenses, escalations, and real estate taxes, we’re now talking at the end of a 10-year lease, you’ve added $19 a square foot.

When you start to think about your next lease and what you will be paying per square foot, you’ll also ask “What am I paying now?” You have to do an apples-to-apples comparison, and an apples-to-apples comparison really can be done by a remaining lease obligation because it tells you what you’re really paying now, inclusive of all other expenses. A second sort of asterisk to that is maybe you’re paying something for cleaning, which can easily be $2 to $3 a square foot. And then there’s the electricity, which, as we know, is anywhere between $2 and $3.50 a square foot. All of this will give you the full picture.

Another reason it’s important to do a remaining lease obligation is for budgeting purposes for your business. You may want to project out and see what you are going to owe over the next few years, after all these escalations and real estate taxes. What do I need to put in my budget? The only way to do that is through a remaining lease obligation, a RLO.

Who does the RLO? That’s something that my team will do, as your advisor and commercial real estate broker. It’s the first thing I do for a client when they are considering office spaces.

What do you need to do the RLO analysis? Your lease, any amendments, your substantial completion letter, and six months of your rent bills. Why six? Because six months will capture at least one cycle of real estate taxes. And I’ll need your lease because I need to be able to look at your lease to understand what it is, when it started, what the commencement is and when the actual expiration is to be able to understand what your full term is for your lease.

Hopefully, this has helped you to understand why it’s so important to have a RLO done. It’s something that we do for free for our clients to help them understand the full picture, and also help them compare terms for their next lease. This way, when you consider another office space for lease and it’s $64 a square foot, and the last lease you signed was 10 years ago, you don’t automatically think, oh, I’m going from 50 to 64. You realize I’m going from 69 (remember that $19 we talked about in escalations and real estate taxes) DOWN to 64! Because as we know with real estate taxes, you go back to zero when you start a new lease. Any questions? Please feel free to contact me.

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