March 6, 2017
Rapidly rising commercial real estate rents aren’t necessarily a boon for landlords. That’s because all-in rates are a combination of a fixed rent and variable operating expenses (OPEX) which can fluctuate every year.
OPEX for Austin’s commercial office buildings hit an all-time high at the start of 2017 — a trend that will likely continue as property taxes mirror historic commercial property values. Although OPEX is composed of many separate expenses passed on to the tenant, property taxes make up approximately half of this expense. Unlike residential property taxes, there is no cap on commercial property taxes. Therefore, taxes on commercial real estate will continue to rise with no limits as long as property values increase year over year.
OPEX is a major contributor to Austin’s historically-high office rental rates. In the central business district (CBD), vacancy rates have remained relatively flat since the latter part of 2014; however, average full-service office rental rates have increased more than 22 percent and the OPEX component by 38 percent in that same time period. The CBD experienced an average OPEX increase from $15.85 in 2015 to a record high of $20.33 in 2017. In one class A CBD office tower alone, the OPEX rate rose more than 25 percent from 2016 to 2017.
Negotiate Lease Terms
For a 20,000sf tenant in the CBD, this OPEX increase will result in a significant impact in annual rent. If that trend continued over the remaining term of a lease, the compounded additional costs to the tenant could run into the hundreds of thousands of dollars. That’s why it’s imperative for tenants to start preparing for this trend during the site selection process. According to Ryan Kasten, executive director, Cushman & Wakefield Austin, “A tenant’s ability to mitigate the risks of rising OPEX costs is severely limited after the lease is signed. It’s critical for tenants to carefully review the lease terms and negotiate controllable expense caps which could offset higher OPEX later.”
Right to Dispute
Although a tenant has little power to affect an assessed property tax value, caps can be negotiated for controllable expenses such as building maintenance and management costs. “Often times, tenants occupying all or a majority of a building can obtain the right to dispute taxes directly, which is a right typically held by a landlord. If the dispute is successful and taxes are lowered, the OPEX will be, too. Having a skilled and knowledgeable tenant representative broker in your corner during lease negotiations can help save you tens of thousands of dollars down the line,” Kasten said.
The Landlord’s Perspective
Tenants aren’t the only ones impacted by higher OPEX. Melissa Totten, director, Cushman & Wakefield Austin, works closely with landlords and understands the pressure higher OPEX has on their investments. “There may be a misconception that an increase in OPEX benefits landlords which is absolutely false,” she said. “Because the increase is mostly due to rising taxes, the landlord is simply passing on the increase without benefiting financially, which may make their property less competitive. Unless there is a gross-up clause in the lease, the landlord is responsible for paying 100% of the OPEX for any space not occupied, and this could severely affect their bottom line,” Totten added.
Prepare for the Long-term
Austin’s economy shows no sign of slowing down. In fact, a recent U.S. News and World Report ranking Austin as the #1 Best Place to Live is proof of its continued healthy economy and bright future. Kasten concluded, “Rising property taxes and OPEX are a part of doing business here for the foreseeable future with OPEX expected to rise even more in 2017 and beyond. It’s every business’ responsibility to prepare for this reality and the experienced brokers at Cushman & Wakefield Austin are ready to roll up our sleeves and help.”