Comparing Loss Factors to Dividend Paying Stocks

Comparing Loss Factors to Dividend Paying Stocks

First off – a quick but important thank you to everyone who read my first post, Responding to the New York Times. People reached out to me through various mediums – e-mail, text, Facebook, LinkedIn – with feedback. I greatly appreciate it and welcome it always.

Just last week, I was helping a tenant renew its lease. When we submitted our offer to renew, the landlord’s agents countered with an offer that was 2,200 rentable square feet larger than our current space. Our space did not grow – the walls on the inside, and on the outside, were the exact same – yet something happened. In this case, the building had been sold which led to the new owner’s remeasuring of the floor to comply with a market loss factor. Essentially, the new owner saw an opportunity to increase the Building’s NOI.

Loss factors are an extremely important metric in commercial real estate; however, changes in loss factor are not formally tracked over time when looking at historical market rent data. Loss factors are increased during strong markets, and interestingly never are decreased in down markets. See year-end stats below from CBRE dating back to 1992.

As you can observe, average asking rents in Manhattan have gone from $28.28 to $71.85. If you think of a single building like a company, or a stock, that stock would have increased 154%. However, this rental appreciation does not factor in the change in loss factors over time. For that reason, building’s with increasing loss factors (which is nearly all of them) can be compared to dividend paying stocks. When thinking of a stock, the total return = price appreciation + the dividend. The loss factor is the dividend, and it’s significant.

Let’s do some quick math. It’s 1992, and the market loss factor for full floors in Manhattan is 20%. You are a full floor tenant and the landlord’s architect and your architect confirm that you occupy 20,000 usable square feet (defined here.) With the addition of a loss factor, your rentable square footage (the number you pay rent on) becomes 25,000 [USF/(1 – loss factor) = RSF].

It’s now 2016, you occupy the same exact floor, but sentiment has changed and the full floor market loss factor is now 27%. When going to renew your lease, your landlord quotes the size of your floor to be 27,397. To keep this analysis “apples to apples,” let’s pretend for a second rents have not changed from 1992 to today, staying at $70 PSF (though we clearly know from the chart above that is not the case.) In 1992, your yearly rent would be $1,750,000; in 2016, your yearly rent for the exact same floor is $1,971,790 (a $167,808 difference (cough:bonus), to the landlord that is paid annually until the end of your new lease.)

Unfortunately for tenants, challenging loss factors is difficult; landlords are typically hesitant to move off of their quoted rentable square footage as long as it’s consistent with other properties. That is why, in all of our proposals, we insert the line below (and fight for it to be included in the term sheet when we can):

The space measurement shall not exceed a REBNY 1987 Usable Area with a 27% full floor loss factor subject to verification by Tenant’s consultants.

All in all, loss factors are just part of the game in New York commercial real estate. In order to make informed real estate decisions, tenants need to be aware of loss factors and floor plate efficiency because you will end up paying for inefficient space (i.e. columns, mechanical space, large convectors, etc.) as part of your rentable square footage. For this reason loss factors and floor plate efficiency – how many employees you can fit on a floor – are just as important as the base rent.