Retail is the only asset class whose tenants report their sales. The occupancy cost ratio turns that report into a test of the rent, if both halves of the fraction are right.
The occupancy cost ratio is the tenant's total cost of occupation, rent plus service charge plus rates or property tax, divided by its sales excluding VAT. Compare it with a ceiling for the trade and you get the rent the unit can actually sustain. On an illustrative six-unit tape with 457,000 of rent, three tenants are above their ceiling and 61,100 a year, 13.4 per cent of the rent roll, is rent no occupier of those units can sustain at current sales.
Worked in full in Retail Real Estate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Retail is the only property type in which the tenant reports what it sells, which makes it the only one in which a rent can be tested against the business paying it. The test is simple. It is also routinely run on the wrong numerator, the wrong denominator, or both, and either error can make a problem disappear.
| Unit and trade | Area m² | Rent | Service charge | Rates | Sales | Ceiling |
|---|---|---|---|---|---|---|
| 1, fashion | 400 | 120,000 | 24,000 | 30,000 | 1,050,000 | 15% |
| 2, cafe | 150 | 45,000 | 9,000 | 11,000 | 520,000 | 12% |
| 3, jeweller | 80 | 48,000 | 4,800 | 12,000 | 900,000 | 10% |
| 4, health and beauty | 250 | 70,000 | 15,000 | 17,500 | 820,000 | 13% |
| 5, value retailer | 1,200 | 144,000 | 72,000 | 60,000 | 2,600,000 | 9% |
| 6, phones | 60 | 30,000 | 3,600 | 7,500 | 400,000 | 11% |
| Total | 457,000 | 6,290,000 |
The ceilings are illustrative, not market data. Each trade has a gross margin, and the share of sales it can spend on occupation follows from that margin: high for fashion, low for value retail and jewellery, where turnover is high and margins thin or stock is expensive. Your own ceilings should come from the tenants' accounts or from your own portfolio's history of failures.
Occupancy cost ratio = (rent + service charge + rates) ÷ sales ex VAT
Sustainable rent = ceiling × sales − service charge − rates
Rent at risk = max(rent − sustainable rent, 0)
In Excel, row by row: =(D2+E2+F2)/G2 for the ratio, =H2*G2-E2-F2 for the sustainable rent and =MAX(D2-I2,0) for the rent at risk. Sum the last column and divide by total rent.
Take the value retailer. Its occupancy cost is 144,000 + 72,000 + 60,000 = 276,000 on sales of 2,600,000: 10.6 per cent, against a ceiling of 9 per cent. At 9 per cent it can afford 234,000 of total occupation. The service charge and rates take 132,000 of that before any rent is paid, leaving a sustainable rent of 102,000. It pays 144,000, so 42,000, or 29.2 per cent of its rent, is at risk.
| Unit | Occupancy cost | OCR | Ceiling | Sustainable rent | Rent at risk |
|---|---|---|---|---|---|
| 1, fashion | 174,000 | 16.6% | 15% | 103,500 | 16,500 |
| 2, cafe | 65,000 | 12.5% | 12% | 42,400 | 2,600 |
| 3, jeweller | 64,800 | 7.2% | 10% | 73,200 | 0 |
| 4, health and beauty | 102,500 | 12.5% | 13% | 74,100 | 0 |
| 5, value retailer | 276,000 | 10.6% | 9% | 102,000 | 42,000 |
| 6, phones | 41,100 | 10.3% | 11% | 32,900 | 0 |
| Total | 723,400 | 11.5% | 61,100 |
The centre-wide ratio of 11.5 per cent looks comfortable and tells you nothing: averages across trades with different ceilings are meaningless. Unit by unit, 61,100 of rent, 13.4 per cent of the roll, sits above what three occupiers can sustain. That is the income most likely to be lost at the next lease event, or earlier through a restructuring request.
| Case | Rent at risk | Share of rent roll | Units over ceiling |
|---|---|---|---|
| Sales +5% | 38,925 | 8.5% | 2 |
| Base case | 61,100 | 13.4% | 3 |
| Sales −5% | 85,025 | 18.6% | 4 |
| Sales −10% | 114,550 | 25.1% | 5 |
| All ceilings one point lower | 108,000 | 23.6% | 5 |
| All ceilings one point higher | 22,000 | 4.8% | 2 |
The response is not linear. A 10 per cent fall in sales nearly doubles the rent at risk, because the service charge and rates do not fall with sales, so the whole loss of capacity lands on the rent. One point of ceiling moves the answer as much as a 10 per cent change in sales, which is why the ceilings deserve more scrutiny than they usually get.
Rent over sales instead of occupancy cost over sales. The value retailer's rent is 5.5 per cent of its sales, which looks safe against any ceiling. But service charge and rates are 47.8 per cent of its total cost of occupation. Large, low-rent units carry proportionately the heaviest non-rent costs, so a rent-only ratio is most wrong exactly where the risk is greatest.
VAT-inclusive sales. Tenants often report gross takings. Divide by sales including VAT at 20 per cent and every ratio falls by a sixth: the fashion unit drops from 16.6 to 13.8 per cent, the value retailer from 10.6 to 8.8, and on this tape the rent at risk falls to 0. A problem worth 61,100 a year disappears because of the denominator.
Read the sales report before believing it. Check whether the figure includes VAT, concessions and online sales attributed to the store, and whether the period is a full year. A ratio is only as good as the sales line under it.
Divide total occupancy cost, not rent, by sales excluding VAT, compare with a ceiling for each trade, and convert the gap into sustainable rent unit by unit. Here 13.4 per cent of the rent roll fails the test. The free occupancy cost and rent at risk workbook runs the same tape on the book's centre, and what losing the anchor costs shows how quickly the figure moves when sales fall.
It depends on the trade's gross margin, so there is no single figure. Illustratively, a fashion retailer might sustain around 15 per cent, a cafe 12 and a value retailer 9 per cent of sales. A centre-wide average, such as 11.5 per cent on the illustrative tape, is meaningless because it mixes trades with different ceilings.
Yes. Total occupancy cost is rent plus service charge plus rates or property tax, and sometimes insurance and marketing levies. Excluding them flatters large units most: an illustrative value retailer paying rent of 5.5 per cent of sales has a true occupancy cost of 10.6 per cent, because service charge and rates are 47.8 per cent of its cost of occupation.
Multiply sales excluding VAT by the occupancy cost ceiling for the trade, then deduct service charge and rates. A value retailer with 2,600,000 of sales and a 9 per cent ceiling can afford 234,000 of total occupation; less 132,000 of service charge and rates, its sustainable rent is 102,000 against 144,000 paid.
This article is one calculation from Retail Real Estate. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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