Retail Property: Occupancy Costs and Their Relevance to Market Rent Determinations
Understanding the Retail Shop Leases Act 1994 (QLD) is paramount to ensuring ongoing financial success from your retail property asset.
As one of a select number of specialist retail valuers in Queensland, I am examining the Act in this new three part series to help you understand important terms and their relation to your retail business.
Part One examined the difference between a shop and shopping centre and Part Two answered some common questions about exclusivity clauses. In this final instalment, I highlight the relevance of occupancy costs in market rent determinations.
Occupancy cost is the operating expense to a tenant of rental accommodation. The application, however, varies between retail and commercial tenancies.
What does occupancy cost comprise?
In the office sector, occupancy cost includes gross rent, plus increases in outgoings or net rent plus outgoings. Energy cost is becoming a component to include in occupancy cost as ‘green buildings’ are capable of delivering significant saving in electricity cost in comparison to older and less energy efficient buildings. Rent review provisions are also taken into account. Within the office sector, occupancy cost is used for comparative analysis of lease options and is calculated over the entire lease term.
Occupancy cost for retail property is the ratio of the annual gross rent to turnover (gross sales) of the business and is expressed as a percentage. It varies for different types of businesses. The same category of business with a low occupancy cost will be more sustainable then one with a high occupancy cost, as illustrated by the graphs below:
Shop A and Shop B have the same GLAR and the same annual rent commencing in Year One of $100,000 p/a, escalated annually at 4%. Annual turnover for Shop A over the five years is trending upwards with the inverse applying to occupancy cost. Shop B, however, has falling turnover and its occupancy cost has trended higher, making the business less profitable and potentially unsustainable if this trend were to continue.
Turnover of retail tenants is subject to many influences. These include prevailing economic conditions at federal, state and local levels. The demographics of the immediate location are a significant factor. A retailer’s trade can also be impacted by inferior location within the shopping precinct or centre, and if there is too much competition. Below average management of the business may also be a factor.
Why is occupancy cost a relevant benchmark in respect to market rent determinations?
Different types of retail businesses have the ability to pay a varying percentage of their turnover towards occupancy cost. However, as illustrated by the differing performances of Shop A and Shop B, the influences that impact trade should be taken in to account when making a market rent determination.
Seldom are the participants in a retail shop determination – landlord, tenant and/or determining valuer – afforded directly comparable market rental evidence. Quite often, rental evidence is not available in the immediate trade area.
While adjustment is made of available market information to reflect varying GLAR, location and other factors, singular reliance on a rental rate per square metre (valuation by comparison) may be deficient. Reference to occupancy cost is a means to support the rental determination on the direct comparison approach. Some would argue it should be the primary method of a determination.
In this three part series on retail property, I have addressed some issues that affect the operations of the retail industry.
In Part One, I gave meaning of Shop and Shopping Centre under the Retail Shop Leases Act 1994 (QLD), and defined Lessees over whom provisions of the Act may not apply. Part Two provided a discussion on an Exclusivity Clause in a Retail Premises Lease, and its reason for being and commerciality were explored.
If you enjoyed the series and would like to subscribe to receive updates from us, please click here.
For expert advice on commercial property management or retail property management, please call our Brisbane office on 1300 076 046 or Bruce Barrington directly on 0411 726 512. Should you require a market rent review report or rental determination under the Retail Shop Leases Act, please click here.