Rent and it’s Potential Impact on Profitability

Rent and it’s Potential Impact on Profitability
With the release of our benchmarking report early in June, the next couple of months will be a great time for firms to review their main KPIs. After staffing costs, RENT is generally one of the next big ticket items. Commonly, rent represents somewhere between 4.5% – 6.5% of total revenue, although a review of current data suggests many regions and areas are presently at the upper end of this range.

The difficulty with endeavouring to manage rent as an expense, is the general length of leases that firms commonly enter into, often representing a three to five year period with corresponding options. Therefore, if a firm enters into a lease and an unforeseen event occurs, such as a loss of fees, a partnership dissolution, a reduction in their required space or a decline in local rental costs, there is more often than not, little opportunity for the firm to renegotiable their rental terms to enable a reduction in this cost.

Likewise, the location of the firm, its premises, as well as the quality of the building, will be influential. I recall attempting to renegotiate a lease at the end of 1999 in Sydney CBD, just prior to the Olympics. The rental market and price expectations were simply mad. Naturally, whether the property is A or B class or commercial verses retail will all be relevant to your typical costs. However, speaking with practitioners across the country, some areas that are currently experiencing a flatter market represent a good opportunity for rental terms. So, it all comes back to timing; how far you are through your current lease term, as well as the potentially adversity to relocation. But, if you commit to an expensive location, it will impact practice profits.

Excess space can be another influence on profitability, driving up rental costs where firms have committed to a space larger than they currently need on the basis that they will ‘grow into it’. Where such an approach is taken, it is ideal to have a shorter lease period should the potential need not eventuate, leaving the firm with a long standing unrequired commitment.

The final factor that we see impacting upon rental costs and subsequent profitability is where the property is owned by the firm’s equity holders or their associated entities. In such circumstances we often find practices paying somewhere between 8% & 12% of revenue towards rent. Yes, this maybe a method of distributing profits, but this is important to remember when it comes time to review the benchmarks.

Thus, for useful benchmarking comparison purposes, it’s important to make an adjustment to a firm’s rental expense where sums charged are not representative of market. This will enable a more meaningful outcome. In addition, at times practitioners may have a uninformed view as to what a fair market rent may be for their property. In such circumstances it could be beneficial to obtain a market appraisal.