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Calculating the true costs of commercial property

Before making a final decision on property, FDs should take into account hidden costs that could create a ‘black-hole' in their balance sheet

SECOND TO PEOPLE, expenditure on offices or any other form of commercial property represents the next biggest slice of an organisation’s budget, yet there is still a lack of understanding around what different property models entail and the true costs they incur.

So if you are looking for a new office or looking to review your existing property portfolio, you need to be aware of what models are available, the pros and cons and also whether there are any hidden or indirect costs.

Historically, the most common way of acquiring commercial property has been via a lease, according to the pound per square foot and length of term.

Leases normally require an upfront deposit with rents (a third of overall costs) payable on an annual or quarterly basis. On top of this you need to factor in business rates (15%), annualised costs (14%), hard FM (23%), soft FM (11%) and management (3%) (Source: Actium Consult, Total Office Costs Survey 2013).

Likewise, with a capital purchase of commercial premises, with the exception of rent, you are subject to the same costs, apart from the fact that you have to free up cash for a deposit, financing or to buy a building outright.

A third option which is gaining popularity is managed office solutions (not to be confused with serviced offices). This is an outsourced property model that essentially provides fully managed business accommodation configured to the bespokerequirements of the occupier, at any location, for a fixed monthly cost. These solutions also include all the internal fit-out & design, IT, furniture, FM and Security, and terms are usually shrter than most leases.

Choosing the most suitable property option?
Picking the most appropriate property strategy will largely be dependent on an organisation’s circumstances and their overall business objectives. There’s no one-size fits all approach, rather all models have both merits and drawbacks, but should be measured on a case by case basis.

Leasing for example may work well for organisations that require the same property footprint in the next 5-10 years, but if you are rapidly expanding businesses or experience a dramatic shift in size or direction you may incur hefty exit charges or dilapidation costs. Changes in the workplace should also be considered, as introducing flexible or home working could potentially leave you with a legacy of excess capacity that you would still be committed to paying for.

According to the latest annual commercial lease review (2012) published by British Property Federation the average commercial property lease has dropped over the last two decades from 21 years in 1991 to 4.8 years in 2011. However, the exception to this is office property that has actually increased in the last 24 months from 8 years to 9.4 years.

For cash-rich organisations, a capital purchase could make good financial sense and if property values continue to rise then buying now could be sound investment for the future. On the downside though, if you tie funds into a property (as much as 25 years), you reduce the amount that could be invested in the business itself – you may have the spare cash now, but it is almost impossible to foresee what will happen in the future.

With owning property you may also face additional costs that are beyond your control such as fluctuating business rates and/or unforeseen charges such as the empty buildings tax that saw a 19% hike in 2012 compared to the previous year. As an owner occupier you can benefit from capital allowances, but you also need to balance this against the costs of managing the property and whether you have the time and necessary in-house skills to manage this successfully.

If you don’t have the resources to manage a property or want to limit exposure to some of the risks inherent in buying or leasing, then Managed Office Solutions (MOS) could be a practical alternative. MOS can provide access to property experts who can bring other tangible benefits, such as insight into better space utilisation and the impact of effective office design on productivity and the bottom line. A typical agreement with an MOS provider can also prevent any unforeseen or hidden costs (see below), because it is an all-inclusive contract.

Whilst MOS has its advantages, FDs should be careful to consider the length of contract that they are prepared to sign-up to, and also be clear on the options available to flex up and down should business requirements change. This is because whilst the terms are typically much shorter than that of a lease, they still require a commitment.

Before making a final decision on property, FDs should also take into account unknown or hidden costs that have the potential to create a ‘black-hole’ in an organisation’s future finances and balance sheet. While it is relatively straightforward to calculate costs such as rent, rates, facilities management (FM), dilapidation and legal fees, below are the typical overheads that are often overlooked.

• The cost of money for capital expenditure
• The cost of overruns – 90% of implementations in the industry go over time and over budget
• Project management of the implementation
• Legal costs associated with a lease
• Maintenance contracts – building, plant and machinery, ground maintenance, day to day (for example carpet cleaning), technology hardware
• Inflation
• Real support people costs – recruitment, training, support, attrition, salaries, salary increases, sickness and holiday cover
• General housekeeping
• The cost of unused space during roll out
• The cost of unused space once the operation is up and running
• Future upgrades – through health and safety regulations, technology advances
• Cost of getting things wrong – such as employee numbers, business forecasts, installing the wrong equipment.

Therefore the true cost of property encompasses a multitude of inherent costs, both identifiable and hidden, from many different sources. In many companies gathering this information can be difficult and time-consuming as some departments maybe slow or unsure of what data is really required or relevant. Incorrect decisions can lead to expensive legacy costs incurred by the likes of inflexible leases and dilapidation that can haunt a company and its balance sheet for many years.

John Gotley is managing director at occupier solutions specialist, Portal

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