Articles

How much more rent will an occupier pay to cut its labour cost by five per cent?

Warehouse rent is set inside the occupier's operating model, where labour and transport dwarf property.

Julian R. Sterling · from Logistics and Industrial Real Estate

On a 20,000 square metre fulfilment operation costing 25,600,000 a year to run, a five per cent reduction in fully loaded labour cost saves 640,000 a year. Spread across the floor area that is 32 per square metre of rent, a 36 per cent premium the occupier could pay and remain exactly as well off. Property — rent, outgoings and energy together — is 2,600,000, or 10.2 per cent of total cost. Rent is not the variable being optimised.

The occupier's cost stack

Take an occupier running a fulfilment operation from a 20,000 square metre building. Rent is 90 per square metre. It employs 400 staff, fully loaded at 32,000 each. Transport, inbound and outbound, is the second-largest line. Fit-out and equipment amortisation covers racking, mezzanines, conveyors and sortation.

Annual operating cost of a 20,000 square metre fulfilment operation.

Annual cost line	Amount
Rent	1,800,000
Property outgoings — taxes, insurance, service charge	500,000
Energy	300,000
Labour, fully loaded	12,800,000
Transport, inbound and outbound	9,000,000
Fit-out and equipment amortisation	1,200,000
Total operating cost	25,600,000

Property cost, taking rent, outgoings and energy together, is 2,600,000. That is 10.2 per cent of the total. Labour and transport carry almost all of the rest, and both of them move with location.

What a saving is actually worth in rent

Run the sensitivities. A ten per cent rent increase costs 180,000, which is 0.70 per cent of total cost: meaningful, not decisive. A four per cent reduction in transport cost, achieved by moving to a site 30 kilometres closer to the centre of the delivery area, saves 360,000 a year. Spread across 20,000 square metres that is 18 per square metre, a 20 per cent rent premium the occupier could pay and remain exactly as well off. A five per cent reduction in fully loaded labour cost, achieved by moving to a location with a looser labour market, saves 640,000, or 32 per square metre — a 36 per cent premium.

Shares of total cost and rent premiums in per cent; effects and rent equivalents in currency units.

Change to the operation	Annual effect	Share of total cost	Rent equivalent per square metre	Rent premium
Rent up ten per cent	180,000	0.70	—	—
Transport cost down four per cent	360,000	1.41	18	20
Labour cost down five per cent	640,000	2.50	32	36
Energy cost down twenty per cent	60,000	0.23	3	3

An occupier will pay a third more rent to save a twentieth of its labour cost. Rent is not the variable it is optimising.

Why the negotiation is not about rent

A landlord's agent reports that an occupier has asked for a rent five per cent below the asking level and will not move. Five per cent of the rent on a large building is a large number to the landlord. To the occupier it is somewhere around half of one per cent of the cost of running the operation, and a party does not dig in over half of one per cent. When a negotiation stalls at that point the sticking point is almost always something else: a reinstatement clause, a delivery date that does not align with a contract start, or an unresolved question about power.

The same arithmetic explains what an occupier will and will not pay for. It will accept a higher rent for a taller building, because racking cost per pallet falls and the footprint needed falls. It will accept a higher rent for a better yard, because vehicle turnaround time falls and the fleet needed shrinks. It will accept a higher rent for a deeper labour market, because it can staff the operation without bidding wages up. It will not pay anything extra for a nicer office, a better reception or a landscaped entrance, because none of those touch a line in the table above.

It also explains walk-aways that look irrational from the landlord's side. An occupier that abandons a deal over a delivery date is not being difficult. A facility that arrives after peak season is worthless for that year, and the cost of missing the season exceeds any rent concession available. Delivery certainty is frequently worth more than price.

What to do with it

• Underwrite rent against the occupier's model, not against the rent tone in the neighbouring estate. If the building saves transport miles or opens a labour pool, the premium is quantifiable and defensible.
• Test the specification claims that move those two lines: clear height, yard depth, dock arrangement, power, and the commute geometry at shift-change times. Cosmetic quality earns nothing.
• At a lease event, trade term for rent rather than the reverse. An occupier that resists an increase but concedes a longer term is saying its sunk fit-out is large.
• Before capitalising rental growth, answer the supply question: if rent here rose by a quarter, what would stop somebody building? If nothing does, the growth assumption is construction cost inflation and no more.

The two buildings that look identical on a specification sheet and let at different rents are not a valuation puzzle. One of them takes a larger amount out of somebody's transport or payroll line, and the rent is the occupier handing part of that saving back.

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