Rent as Percent of Sales isn’t a Predictor

Tom Crouser September 4, 2011 0
Question to Ask Tom from a printer: “What percentage of sales should rent be?”

Tom’s Answer: A simple answer would be a specific number such as 4.5% for print shops. That’s what one 2005 study reported but that isn’t a good benchmark for you IF you are trying to predict your sales based on the rent you pay. Why? Rent as a percent of sales is a RESULT, not a predictor. If the landlord doubles your rent, that won’t increase your sales. Besides, rent as a percentage of sales is better expressed as a range rather than a specific number because there are things that impact rent.

It is true, however, that in a retail environments, rent is more of a predictor since higher traffic locations yield more sales. It’s even common in malls for businesses to pay rent based on a flat rate plus a percentage of sales.

However, for printers and plumbers and cigar shops and many other businesses, rent doesn’t create sales because we’re not dependent on drive-by traffic. Now, it is true that a more visible location will tend to be an influencer on sales if done properly. A cigar shop, plumber or printer will tend to do more business with a more visible location but again, there is not a direct correlation, only an indirect one. Oh, why did I throw cigar shop in there? After all, aren’t they a retail business? Yes, but cigar smokers like many other specialty consumers will seek out a shop regardless of location. Same holds true of barbers and beauty shops and more, although the higher visibility shops will tend to get more initial business.

Specifically, a predictor has a correlation between itself and sales volume. Number of employees multiplied by the industry average sales per employee in a printing company would be better predictor of sales but, still, that is largely dependent on sales activities.

More importantly, above and beyond the retail vs. industrial or business location, there are a lot of other special influencers on rent in small business.

+ Businesses that are C Corporation and whose owners also OWN the premises usually pay rents at the high end of market value so the owners may receive income without paying payroll taxes. It’s a common way to take money out (however it is not fool-proof by any means so make sure the rent has relationship to what the property would actually rent for in an arms’ length transaction).

+ Flip side of that is when the business occupies property of the owner, just as often the rent paid is BELOW market prices. Why? Sometimes mom and pop own the property and now junior owns the business and they don’t want to charge him much or the owner’s (usually the husband) wants to show that he’s making more money that he is to someone else (usually the wife).

+ Sales have dropped dramatically and what use to be a $2 million shop is now a $1 million meaning the rent has doubled as a percentage of sales.

To test my theory, I had ten financial statements of current clients pulled and we measured rent as a percentage of sales.

Here are the two upper extremes from this sample:

1) 8.6% in a New Hampshire business location owned by the shop owner. And yea, he is paying top dollar for the building corporation needs the cash flow. The building includes more than the print shop and, unfortunately, much of it is vacant.

2) 8% of sales in a District of Columbia retail type location not owned by shop owner. And this is a condition of the market they serve which is a larger university community.

And now, here are two lower extremes:

3) 4.4% in Midwest commercial location. Junior is paying mom and dad rent as well as buying the business from them. The amount of rent is based more on what mom and dad need rather than fair market value. In this case, junior anticipates inheriting the business someday.

4) 2.3% in San Francisco industrial location owned by the father of the shop two owners, who happen to be brothers. Pop and his brother started the business years ago and it transitioned to pop’s two sons and, again, they are paying rent based on what pop needs rather than fair market value. In this case also, the real estate is expected to be inherited by the brothers.

So, you can see how specific situations can impact rent as a percentage of sales. Now, removing those extremes, I found a tight little band of rent as a percentage of sales which ranged from a low of 5.1% and a high of 6.4% with a typical of 6% (median or number in middle) which is the real answer.

Answer: rent typically ranges from 5% to 6.5% with a typical of 6%

Yea, butta it was 4.5% in 2005? True, but I attribute this to the fact that sales have dropped in the industry as a whole while rents have stayed steady, thus pushing them up from 4.5% to more like 6%.

So what can you conclude from this? IF your rent is 20% of sales; then you either are paying too much per square foot (being in retail location when not necessary for instance) or have too many square feet.

ON the flip side, if your rent is 2%, then you can assume you either have a really good deal, you or a relative owns the building, or you have inadequate facilities.

Hope this helps.

Curious though … Why do you ask? Give me some details and I might be of more help.

In the meantime, thanks for asking…. (To be continued)

Tom Crouser

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