Potato Chips and Leasing

Nov 12, 2016

We’ve all done it. Opened up a bag of potato chips to find a lot of empty air where the afternoon snack should be. In the food industry there’s a name for all that air. It’s called “Slack Fill.” Food producers will tell you that there is a legitimate reason for Slack Fill. They say it is necessary because of today’s high-speed packaging machinery, or to prevent the product from breaking during shipment, or to keep the bag from breaking when trucked through high-altitude areas, or to discourage theft in the stores. Right. We all know why it’s there. It’s to give the illusion of more product.

It’s not just potato chips. It happens with many consumer products. In June of this year, the Wall Street Journal ran an article entitled “How Do Companies Quietly Raise Prices?”. It seems that spice maker McCormick & Co. quietly reduced the amount of pepper in its iconic red and white tins by 25% without changing the price. When challenged by the reporter about this practice, the CEO of McCormick stated that “Our priority was … avoiding significant increases in the price of this favorite everyday ingredient.” Did he just say that selling 25% less product for the same price is not a significant price increase?

But food industry marketers have nothing on the real estate industry.

Let’s start with the unfortunate fact that humans are terribly inaccurate at perceiving size. Do you really know what 4.7 ounces of potato chips looks like or how many ounces of pepper would fit in a McCormick tin? Those are tough questions, so let’s start with one that seems easy: how big is a rentable square foot of office space?

If you thought it was an area 12″ x 12″, then you’re like most people, but you are also wrong. Rentable square feet, like the air in a bag of potato chips, was developed to create an illusion of getting more than what is really there.

If you ask someone in the real estate industry how rentable square feet is determined, they will probably answer that it is the usable square feet plus an add-on factor, all determined in accordance with the standards promulgated by the Building Owners and Managers Association International (“BOMA”).

Greatly simplified, usable square feet under BOMA is the “carpetable” area with no exclusions for columns or other vertical penetrations.

The add-on factor is in theory an allocation of common areas (entry lobby, elevator lobbies, restrooms, janitorial closets, utility closets) to each tenant in proportion to their size in the building. Add-on factors typically range from 8% to as much as 32%.

It may seem complicated, but at least it’s mathematical – right? Far from it.

First, the BOMA standards are very complex and subject to interpretation. Ask five architects to determine the rentable square footage of a given office space, and you will most likely get five different answers.

Second, not all landlords follow BOMA. New York City landlords are notorious for aggressive measurements with the joke being that they measure your space to the centerline of the street (the joke is not that much of an exaggeration).

Third, the add-on factor for a building can often depend upon which floor you are on, even if you are the only tenant on the floor.

And if that’s not enough to convince you that rentable square feet is a total fiction, finally and most amazingly, the total rentable square feet in a given building can vary over time, and often increases each time the building changes ownership. For example, last year we took a hard look at 666 3rd Ave. in New York City for one of our clients. In 1990 the building was listed as having a total of 589,660 rentable square feet. By 2014 the property had “grown” by 31% to 769, 503 RSF – without adding any real space. On a simple spreadsheet, the property didn’t raise an eyebrow with an asking rate of $73 per rentable square foot. But when considering the “Slack Fill” that had been stuffed into the building over the last 25 years the effective rate jumped to $95 per square foot.

Just like the size of a potato chip bag distorts your perception of what you’re getting, focusing on the cost per rentable square foot when deciding among buildings can be deceiving. Perhaps we can take a lesson from the tags we’ve all seen on the grocery shelves that disclose the cost of the product per ounce/ pound/ or other standard unit of measurement.

If rentable square feet is not a reliable standard of measurement of what you are getting in real estate, what is? It’s really as simple as figuring out what each building will cost to house the functions your business requires. How many offices of what size, how many workstations of what size, how many conference rooms of what size, and so forth. This is your organization’s space program. And your space program should be “test fit” into each building under consideration to determine not the rentable square feet required (since we know that can be full of air) but the total annual rent you will pay to house your requirement. After all, if Building A’s rent per square foot is 12% lower than Building B’s, but Building B is 15% more efficient for your particular space program, Building B is more cost-effective.

Even if we were to be able to wave a magic wand to get all landlords to measure rentable square feet in the same fashion, test fits would still be required to determine the true relative cost-effectiveness of buildings. Differences among buildings in column spacing, window spacing, distance from windows to the building core (restrooms, fire towers and mechanical rooms) and other physical factors can dramatically impact the efficiency of a building for your particular requirements. We’ve seen the same building work very well for clients with a particular mix of walled offices and open space and work very poorly for other clients having a different mix.

And remember, everything in a real estate lease is negotiable, including the “air” that is pumped into the number of square feet you have to pay rent on. Do your test fits early in the process, and make sure your broker is working with your architect to strictly adhere to your space program requirements in performing the test fits. The process of test fitting the buildings you are considering should be more than a simple design exercise. It needs to produce a reliable apples-to-apples comparison of each building’s relative efficiency for your particular needs.

There’s nothing more satisfying than watching a landlord struggle to overcome an inherent inefficiency in their building for a tenant’s particular space program. We’ve seen landlords lower the rent per square foot, “re-measure” the proposed space to reduce the rentable square feet, and even give the tenant a lease signing bonus once it’s proven that their building is inefficient for this tenant’s needs. Everybody wants to win, even landlords. Make sure you give them objective information on the relative efficiency of their building for your particular requirement so that they can fully compete for your business. And tell the landlords you won’t be swayed by the air they’ve stuffed into that potato chip bag.

This post courtesy of Exis Global