What Are Tenant Costs In A Commercial Office Lease?

South Africa, a country with great entrepreneurial spirit in emerging industries, continues to inspire foreign interest, with visitors returning year on year to enjoy the glittering coastlines and top-class entertainment and cuisine.There's also an electric start-up and entrepreneurial culture here which has bolstered collaboration and in turn the demand for commercial office space. Although the shift to working remotely has been beneficial for some, more staff have chosen to return to the office in search of a work space conducive to creativity and productivity, and separate from the sanctity of home.

To gain some expert industry advice into leasing costs for tenants, our very own office broker Cindy Venter shared her insights. Cindy has been in sales and logistics for the majority of her professional career, so graduating to property was a natural step. Having launched her property career with Vermaak Properties, it's clear to see Cindy's dedication to being a knowledgeable and trustworthy commercial broker.

"My experience at Vermaak Properties is beyond amazing. Peter, the owner of Vermaak Properties is such a supportive leader, he focuses first and foremost on his employees and invests in us, checking in regularly to make sure we're happy. We have an incredible atmosphere at the office as well - we work hard towards our successes together, and in this unified goal we have bonded like a family. I couldn't ask for a better company to work with."

When discussing the current changing market, Cindy expresses a healthy optimism.

"We're receiving inquiries most commonly for 3-5 year leases again, after tenants during lockdown were choosing shorter leases and landlords had to make provisions for the shocked market."

First-time renters in this fast-changing market - having shifted from a tenant's market during the various stages of lockdown to the current lean back to a landlord's market - need to consider a variety of factors when assessing the affordability of a new business premises. Space and location are important attributes, as are the lease costs involved in office rental payments, which can vary substantially. Becoming acquainted with the detailed costs of a commercial property lease is a great launching point to confidently sign an office lease that suits the tenant's business. A financial budget that fails to allocate funds towards property maintenance or operations can cause a huge amount of stress on a business in the long-term.

In addition to the financial ramifications of a commercial lease agreement, some critical items tenants could overlook include legal and contractual implications. Most tenants opt for the easy route and don't take the time to understand commercial property leases to make informed decisions about how the space they wish to occupy will work best for their business. In saying that, however, Cindy has most often dealt with tenants in a commercial office setting who opt for the Standard, or Gross lease.

"A gross lease is made up of the net rental, calculated by square metre of rentable area which usually includes the common area - lifts, kitchens and bathroom, plus the amount for operational pro-rata charges or "ops costs", and municipal charges and utilities."

What do tenants pay towards operational costs?

Ops costs can vary depending on the property's features and the landlord, as they determine the pro-rata, per-square-metre amount that each tenant contributes towards the building's operational costs. Generally, operational costs the tenant contributes towards include security, cleaning, and general day-to-day maintenance of the internal premises (the landlord most covers the cost for the exterior), and can sometimes include a portion for a generator.

What about municipal charges and utilities?

It's equally important to understand the types of agreements available for leasing a commercial office, and the items that are included or excluded from the tenant's account. One significant monthly expense included in the tenant's rental amount is composed of municipal charges for the premises, and utilities. In a multi-tenanted building, occupants are required to pay pro rata towards municipal services such as sewage, refuse removal, water, and common area lights. The amount is shared equally between all tenants and paid in arrears.

Tenants can also expect to pay for their own electricity and water. Electricity and water metres are usually placed in each office or building. The rate varies depending on the type of building, but typically billed as a percentage of the whole, and sometimes billed individually. Knowing your rights and obligations as a tenant puts you in a steadfast position to negotiate with the landlord terms to the lease agreement acceptable to both parties.Transparency in the general property upkeep and running costs is also beneficial for a business to plan ahead and budget accordingly, so tenants would be wise to request a breakdown of what is included in the gross rental amount and how these costs are covered collectively by the office building occupants.

As Cindy states, Standard or Gross lease agreements are commonly used in office rentals. However, she's been met with some interesting and unique inquiries, such as businesses who anticipate growing their team within a two year rental period who want to know the best option to avoid having to move premises entirely in a case of company growth, as moving is a significant business expense.

"Pursuing the tenant's best interest, we'd advise this tenant to sign a two or possibly three-year lease with a clause within the contract known as the' right of first refusal', where the tenant has the first option to rent additional available space once they outgrow the space they first occupied."

In some cases a building is occupied by a single tenant and at times for an extended commercial lease duration. In this case it would be advisable for the tenant to opt for a Triple Net lease.

What is a Triple Net lease?

This is a lease agreement where the tenant is responsible for the property maintenance and taxes/insurance. Ordinarily, Triple Net leases are found in commercial property, and can be beneficial to a tenant who plans to stay at the same premises for a longer lease duration, as well as the landlord - the tenant can negotiate a lower rental amount and has control over maintenance costs, while it provides a steady income for the landlord. Cindy has some great advice about how the rental amount is determined in a Triple Net lease, for tenants who may be considering this for their business.

"Tenants should be aware of the capitalization rate as this is used by the landlord to calculate the lease amount, as this is determined by the tenant's creditworthiness.

These are the basic costs involved for tenants in commercial property rentals, under the structures of the two most commonly found rental agreements - the Standard lease and the Triple Net lease.

Depending on what additional requirements a business may have, there are some potential extra costs for the tenant's account, however, these are negotiable to a certain degree.

What is the standard cost of Parking?

Parking comes in the form of open, shaded or secure basement / garage bays. Parking bays can cost from R500 to R1,000 per month, depending on where in the parking area they're located and what they offer (such as shade-cloth or additional security in a garage).

How do escalations work for tenants?

Taking the annual escalation rate into consideration when trying to determine the financial viability of a commercial lease is also important, and Cindy ensures her clients are aware of this as it can impact a business down the line.

"Escalations are agreed upon by the landlord and the tenant, and the current market escalation rates are generally in the 7-8% range, although these can fluctuate. This escalation rate usually applies to the basic rental rate and parking. The rent increases are discussed at the renewal period."

Do tenants ordinarily get their deposits back?

Commercial property landlords usually request a deposit to the value of two-months' rent or in the form of a guarantee. Should there be no major costs involved in reinstating the premise or outstanding debts, the deposit is returned to the tenant.

When does VAT apply?

VAT amounts, and whether the quoted amounts for an office lease are inclusive or exclusive of VAT is especially important for non-VAT-registered businesses to establish. Marketed amounts in the South African commercial property context are usually quoted exclusive of VAT.

Do tenants pay for the Lease Administration?

Landlords often do charge for lease administration fees. This fee is for drawing up the lease, processing FICA documentation, and vetting the tenant. The fee can be a few hundred rand or it can be a couple thousand rand and is therefore important to establish what the fee will be before signing the contract.

Cindy summarises the cost breakdown of monthly rentals to her clients in order to empower them in making informed decisions.

"You have your gross rental amount, which is the Net rental plus operating costs, municipal rates and utilities which are most likely metred and charged separately.

Sometimes there's a small amount added for a generator. Some landlords charge a maintenance fee, and some charge a property management fee. TI usually is enough to improve the condition of the space, but not to get furniture."

If you're thinking about taking up a commercial office lease and you'd like some expert advice, get in touch with the professional team knowledgeable in all things property today at Vermaak Properties.

We are motivated and excited to see what's to come this year in the commercial property sector. Further amendments to the Adjusted Alert Level 1 COVID-19 regulations have broadened freedom of movement for the general public and we are cautiously optimistic life is beginning to return to normal, which bodes well for the South African property industry.