Last year, I was consulting on a project for a long time client of mine who was considering developing a mixed-use building. The client worked with their architect and developed a plan consisting of two levels of parking in the basement, along with one floor of retail on the ground level and three floors of hotel rooms above (128 total hotel rooms). The client asked our team to give them a budget for the development to determine its economic feasibility. We kept talking in terms of cost per square foot, and I gave them some construction costs that fit within the budget. The square foot cost of the development was within the expected range, but the overall cost of the development seemed high. To help understand the variables a bit more clearly, I broke the costs down into cost per revenue unit ($/space for the parking, $/sf for the retail and $/key for the hotel). It turned out the appropriate UNIT costs for the parking and hotel uses were too high. We worked with the team and investigated acquiring the adjacent lot, which would have allowed us to consolidate all of the parking below grade with an extra half floor. While the cost per SF for the garage increased, it became a much more efficient design and as a result the cost per parking space dropped by 20%. We changed the cost metric to match the revenue metric, and the deal made sense. In addition, we were able to simplify the structure of the building by eliminating one set of structural transfers, and were able to reduce the height of the building by one floor. Ultimately, we were able to increase the amount of retail area and hotel rooms (resulting in a $6,000,000 revenue increase) while increasing the project cost by just $500,000, even after taking in account the added land cost. When I work with clients evaluating multiple spaces or buildings, I often hear people talking in terms of cost per square foot. They will say, "space A is 1200 sf and has a rent rate of $25 per square foot and will cost $50 per square foot to buildout. Space B is 1000 sf and has a rent rate of $28 per square foot and will cost $50 per square foot. Space A is the better deal." The appropriate answer is it depends. How does your business generate revenue for that space? If you are a health care provider, maybe it is per treatment location. If you are a retailer, it may be by lineal foot of display space. For a restaurant, it is probably by table. Not all spaces are created equally and it is important to evaluate the specific conditions of a particular space as it relates to your needs. If you can fit all of your business needs in a smaller space, a higher rental rate may be justified as your expenses (taxes, utilities, rent) are all based on square footage. Oftentimes, building owners will cram in additional square footage to maximize floor area ratio, rationalizing that the end user will pay for it and their profitability will increase. This is a common trap. First off, the owner will find that most of their costs for the superfluous area are based on square footage (construction costs, soft costs, interest carry, commissions, etc), while most users will only pay for space that is valuable- especially in today's market where higher vacancies across most asset classes make for a user's market.
