Explaining the Loss Factor

I have been working in commercial real estate for almost 20 years and the one conversation I have more than all others involves the concept of  “Loss Factor.” It comes up because either the tenant has never heard of it, or they understand the concept but are annoyed by how high it is for their preferred building. This has been an issue in real estate for decades. I’ve touched on it before and and people continue to try and solve it, as the Wall Street Journal reports today.

Stated simply, the loss factor is a calculation that allows the owner of a multi-tenant building to demonstrate that they can theoretically lease 100% of the structure. It allows the landlord to account for areas where they would otherwise be unable to collect rent, such as the lobby, elevator shafts, bathrooms, hallways, etc.

There is a formula to attach the proportionate share of these common areas to each lease, effectively increasing the square footage stated in the lease from the “Usable Area” to “Rentable Area.”

The difference between the Usable Area and the Rentable Area is the loss factor, and it’s stated as a percentage. The calculation is:

 (Usable Area – Rentable Area) / Rentable Area = Loss Factor

A real life example would be:

(10,000 sf – 12,000sf) / 12,000sf = 17%

This is fine, in itself, if every building used the same standard for measuring loss factor, but they don’t. The Building Owners And Managers Association (BOMA) has a standard, but it is not applied consistently. The Real Estate Board of New York (REBNY) also has a standard for NYC buildings, but it is not universally accepted either.

This is a high-stakes discussion and it’s understandable that these differences can create frustration for tenants(and for landlords alike. When two spaces that each hold 50 people measures differently from one building to another, that difference can account for tens of thousands of dollars in income for a landlord or expense for a tenant.

 

Effort vs Results

I am working with one of the guys in my firm, and when I asked him why we hadn’t moved a specific project forward, he told me with an exasperated tone, “I’m trying!”

I’m sure he was trying. And I didn’t doubt his effort for a moment. There is no indication that this guys is lazy or avoids his responsibilities. And I’m glad for his effort.

But, here’s the thing… As Bill Parcells was so eloquently quoted in the book about a week in the NY Giants 1989 season, “there are no medals for trying.” I know that’s harsh, but that’s the truth. 

It’s also crap.

The reality of this discussion is that there are two sides, and it just depends on your perspective.

When you wake up in the morning and go to bed at night, all that matters is effort. You have to look yourself in the mirror and know that you tried your best, you broke your ass, and you gave it everything you had. In those moments of introspection, success and failure don’t matter. What matters is whether you can look yourself in the mirror and be proud of the effort you put forth.

But at the same time, life is a results-driven business. Everybody around you only cares about outcomes. There is no concern about effort. If you woke up, did the bare minimum, but exceeded every external goal and measure that your peers, coworkers, family, etc put on you, then they will be happy with your performance and the value you’re adding.

It’s easy to beat yourself up when you fall short of your goals despite your best effort. This is useless self flagellation. Have pride in your work, and focus on process, results be damned. 

It’s also easy to get seduced into cutting corners, doing just enough to keep those around you happy, and only feel validation from outside praise. This is shallow victory. Know that these people will be gone the moment you are no longer adding value to their lives.

The trick is to balance these competing dialogues. Understand that you have to be happy with your effort, but don’t expect anybody else to care about anything but results.

Information Asymmetry in Real Estate

Information asymmetry  is a challenge that has existed within the real estate industry since the beginning of time. Whether we are dealing with agent-principal conflicts as they relate to adverse selection in a lease negotiations, there is usually one party that has more information than the other. It’s not a perfect market and decisions don’t get made at the press of a button.

This opacity has been blamed on the brokers, and to a certain extent, it’s a fair point. Brokers have pitched tenants with the message that they have access to the information and can help a tenant see through the fog. There are firms like 42Floors, JLL’s HiRise, etc that are trying to make the market more transparent, but it’s not just a problem of eliminating brokers.

Landlords are big beneficiaries of this dynamic too. They see a lot of pricing data, both from the investment side (people making offers to buy their buildings) and from the leasing side (proposals they receive from tenants interested in leasing space.) I’ve heard plenty of stories about landlords leveraging tenant ignorance to hold rents higher, provide fewer concessions, and generally increase their margins. (I don’t blame them. I would do the same thing if I was in their position!)

What tenants need is negotiating leverage when engaging with the market. They need assistance in aggregating all of the terms that might be negotiated, establishing value for those terms, and playing one building off another to get the best possible deal.

Brokers can no longer depend only on offering tenants access to traditional data points such as visibility to the market through listing services like Costar, a “comps database” or Tenant In Market (TIM) reports. While these might make a tenant feel more in tune with the market, the fact is that this information is either readily available or unreliable. The Multiple Listing Service is available on line for a fee, comps only provide a historical record of where landlords were willing to do deals, and TIM reports aren’t terribly accurate or reliable.

Don’t get fooled into thinking that you can fight information asymmetry through data collection. Level the playing field by creating your own market!

How’s the market?

It’s a question I get a lot, and here’s the basic answer: If you hire the right broker, it doesn’t really matter. From a tenant broker’s perspective, I’ve seen unbelievably high-priced rents in the midst of “terrible” markets and world-beating pricing achieved in “strong” markets.

Instead of thinking about the market in terms of “strong” or “weak,” understand that a market is made when a buyer and seller agree on the price. That price is made up of many components. A good broker understands how to play these dynamics towards their client’s advantage. Landlord brokers will try to create scarcity and get the tenant to make a quick decision. The tenant’s broker will look for alternate options and force the landlord to compete for price.

Yes, rental rates increase when vacancies decline. But vacancy rates are never zero. There are always options, and a savvy broker will help his tenant leverage those options to drive a better deal.

Early in my career, a client told me, “There’s always another option” and it was a good lesson to learn. No matter what is happening with the market, you can get the deal you want if you look for the right solution.