An amenity floor trades certain rent for a hoped-for premium and occupancy gain. The largest cost is the rent the floor would have earned.
Converting an office floor to amenity space pays only if the rent premium and occupancy gain on the remaining floors replace the lost rent, the running cost and the capex. On an illustrative 10-floor, 10,000 m² building at 500 per m² and a 6.0 per cent yield, giving up one floor needs a rent premium of 6.63 per cent on the other nine if occupancy rises from 85 to 92 per cent, and 17.39 per cent if it does not.
Worked in full in Office Real Estate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Amenity floors, lounges, gyms, event space, are the standard response to half-empty offices: give occupiers a reason to come in, and a reason to choose this building over the one next door. Whether that is a good trade is a sum, and the largest item in it is the one most proposals leave out, the rent the floor would have earned.
| Input | Value |
|---|---|
| Net lettable area | 10,000 m² (10 floors of 1,000) |
| Market rent | 500.00 per m² |
| Stabilised occupancy today | 85% |
| Landlord's cost of vacant space (service charge, rates, insurance) | 120.00 per m² |
| Amenity fit-out capex | 1,800 per m² (1,800,000) |
| Amenity running cost, not recovered | 150.00 per m² (150,000) |
| Occupancy expected after conversion | 92% |
| Valuation yield, before and after | 6.0% |
Values are capitalised net operating income: rent on let space, less the landlord's cost of vacant space, less the amenity's running cost where there is one. Occupancy is the long-run average the building can hold, not today's figure after one large lease event.
NOI = 8,500 m² × 500 − 1,500 m² × 120 = 4,250,000 − 180,000 = 4,070,000
At 6.0 per cent, value is 67,833,333.
Nine floors, 9,000 m², are left to let. At 92 per cent occupancy, 8,280 m² is let and 720 m² vacant.
NOI = 8,280 × 500 − 720 × 120 − 150,000 = 4,140,000 − 86,400 − 150,000 = 3,903,600
Value at 6.0 per cent is 65,060,000; after the 1,800,000 of capex the landlord is 4,573,333 worse off than doing nothing, even with the occupancy gain.
To break even, the scheme must earn the old NOI plus a 6.0 per cent return on the capex: 4,070,000 + 108,000 = 4,178,000. Without a premium it earns 3,903,600, so the premium has to bring in 274,400 a year on 8,280 m² of let space.
Break-even premium = 274,400 ÷ (8,280 × 500) = 6.63 per cent, or 33.14 per m²
In Excel, with the current NOI in B2, the capex in B3, the yield in B4, the scheme's NOI with no premium in B5, the let area in B6 and the rent in B7: =(B2+B3*B4-B5)/(B6*B7).
If the amenity does not move occupancy, and the building stays at 85 per cent on its nine remaining floors, the break-even premium is 17.39 per cent, 86.93 per m². Few occupiers pay that for a lounge.
| Rent premium | Occupancy 85% | 90% | 92% | 95% |
|---|---|---|---|---|
| 0% (500.00) | -11,083,333 | -6,433,333 | -4,573,333 | -1,783,333 |
| 3% (515.00) | -9,170,833 | -4,408,333 | -2,503,333 | 354,167 |
| 5% (525.00) | -7,895,833 | -3,058,333 | -1,123,333 | 1,779,167 |
| 8% (540.00) | -5,983,333 | -1,033,333 | 946,667 | 3,916,667 |
| 10% (550.00) | -4,708,333 | 316,667 | 2,326,667 | 5,341,667 |
Occupancy does more of the work than rent. Each point of occupancy on the 9,000 m² is worth 45,000 of rent plus 10,800 of void cost saved, 55,800 in all; each point of premium on 8,280 m² of let space is worth 41,400. The break-even premium falls from 17.4 per cent at 85 per cent occupancy to 12.6 per cent at 88, 9.5 per cent at 90, 6.6 per cent at 92 and 2.5 per cent at 95.
The yield can move too. If the valuer accepts that the converted building is a better product and capitalises it at 5.75 per cent instead of 6.0, the break-even premium at 92 per cent occupancy falls to 2.42 per cent. At 5.50 per cent, the conversion adds 1,341,212 of value with no premium at all. That is the case most schemes are really relying on, and it is the hardest one to evidence before the work is done.
The usual business case spreads the amenity's annual cost, 150,000 of running cost plus a 6.0 per cent return on 1,800,000 of capex, over the existing rent roll of 4,250,000 and concludes that a premium of 6.07 per cent pays for it. That ignores the floor itself: at today's occupancy it earned 425,000 a year, more than the running cost and capex charge combined. Once the lost rent is counted, the premium needed without any occupancy gain is 17.39 per cent, almost three times the shortcut.
The test, in order: what the floor earns today, what the amenity costs to build and run, then how much occupancy and rent on the other floors must improve to cover both. If the answer depends on occupancy rising seven points, the scheme is a leasing bet, and should be underwritten as one, with the void and incentive evidence that a leasing bet needs.
The same arithmetic of rent forgone against value created runs through whether a Cat A+ fit-out pays the landlord, and the cost of vacant space is worked in what a high service charge costs an office landlord.
An amenity floor is a trade of certain rent for uncertain rent. Here it pays at a 6.63 per cent premium if occupancy rises to 92 per cent, at 17.39 per cent if it does not, and at no premium only if occupancy rises to 92 per cent and the market also rewards the building with a yield half a point lower. Office Real Estate covers repositioning and re-leasing economics, and the free workbooks for the book include the refurbish, reposition, convert or sell decision.
Enough to matter only if the amenity also lifts occupancy. In the illustrative case, a converted floor breaks even at a 6.63 per cent premium when occupancy rises from 85 to 92 per cent, and at 2.5 per cent if occupancy reaches 95. With no occupancy gain the remaining floors must pay 17.39 per cent more, 86.93 per m2.
The rent the floor would have earned. In the illustrative building it earned 425,000 a year at 85 per cent occupancy, against 150,000 of amenity running cost and 108,000 for a 6.0 per cent return on the 1,800,000 fit-out. A business case that leaves out the lost rent finds a break-even premium of 6.07 per cent instead of 17.39.
It can, but it is the hardest assumption to evidence. If the valuer capitalises the repositioned building at 5.75 per cent rather than 6.0, the break-even premium at 92 per cent occupancy falls from 6.63 to 2.42 per cent. At 5.50 per cent the conversion adds 1,341,212 of value with no premium at all.
This article is one calculation from Office 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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