How much is enough?

One of the first questions a real estate broker asks any prospective tenant is, "How many square feet are you looking for?" Some folks have a definitive answer, but oftentimes this simple question can elicit a vague response. This uncertainty is understandable. The consequences of committing to a lease in a space that doesn't fit a company's needs is far more painful than an ill-fitting pair of shoes and can even threaten the very life of your firm. So, how do you decide how much space is appropriate for your needs?

There are many different ways to approach this problem. While no one way is always correct, the following methods (or a combination of methods) can provide some insight into this dilemma.

Competitive analysis,

or how green is my neighbor's grass?

Few businesses have a truly unique and revolutionary business model. Start by visiting your competition or companies engaged in a similar business. Estimate the space they occupy (measure the outside walls or count ceiling tiles most are 4 feet by 2 feet) and look for signs of under- or over-utilization, such as excess product moved outside. This is a sure sign they are busting at the seams because no one wants to pay employees to move product in and out of the building each day. On the other end of the spectrum, dark offices, wide open spaces, or signage advertising space for sublease indicates less space is needed for this type of business. Finally, ask yourself if you can operate your business over the next three to five years in this size space.

Budgetary analysis

or how much can we afford?

Rather than simply pick a budget number out of the air that feels good, consider the following: you don't want to pay more in expenses than your revenue can support. The ratio of lease expense to gross revenue is called a rental factor, and it differs by industry and by the size of the business.

To determine the rental factor other companies of your size and in your industry are paying, try visiting the free website, bizstats.com. This site collects the information provided by publicly traded companies and allows you to enter your annual gross revenue, select your industry, and see the average expenses similar businesses are paying. For example, choose "Manufacturing - Printing & Related Activities" and enter $5 millioin for annual revenue. Hit submit. A table will return showing the average profitability and expenses paid by similar companies. The "Rent - Office and Business Property" line reveals 3.2 percent is the average rental factor for this size and industry.

Armed with this information when looking at spaces in the market, perform a simple calculation: Lease Payment divided by Rental Factor equals Required Revenue. So, if you are looking at a space that costs $10,000 per month, then $10,000 divided by 3.2 percent equals $312,500 per month in revenue required to support that space. Ask yourself if your gross revenue is more or less than $3.75 million annually. If not, you may want to pass on that space. You can also take your gross revenue for the past year, divide by 12, and divide the answer by your rental factor. This provides a monthly budgetary number to use when determining your target space.

Demand analysis,

or where am I going to put all this?

Call it what you will "production area", "company roster", or "inventory" identify the factor driving your requirement for physical space. Use one or more of the following heuristics to arrive at an estimate of the size space you need.

* Workroom - if you manufacture, assemble, or otherwise produce a product, it makes sense to identify how much room your production process requires to operate at optimal efficiency and acquire only the space required to do so.

* Office space per employee - 250 square feet per employee or 1::250 is a good rule of thumb for general office space. If you have folks in cubes or in a call center the ratio is closer to 1::100. If you have a law firm, financial services company, or medical use, the ratio is closer to 1::400. Space planners or office furniture companies can give you a more specific idea of how much space you'll need for your employees based on the type of workspace they utilize.

* In a warehouse, the space your average amount of inventory occupies is a good starting point. Keep in mind, however, that your annual peak inventory must be accommodated somehow. If you have a great deal of variance in inventory throughout the year, consider finding an outsourcing partner who can take your overflow in peak periods, allowing you to pay for only the amount of space you most often use. Otherwise, you'll have to lease more space, pack your product in tighter or higher at peak periods, and/or manage your supply chain more efficiently. Sophisticated warehousing and distribution companies use a number of metrics to monitor the number of inventory turns, warehouse efficiency, and space utilization they achieve. Based on the changes in these metrics over time, they are able to forecast the amount of space they will likely require into the future.

Strategic analysis,

or what am I going to be when I grow up?

One of the most significant challenges of picking a new space to lease is that most commercial leases require a three- to five-year commitment. Inevitably, business owners must ask themselves if the space that fits their need today will still work three to five years from now. An interesting paradox presents itself in this discussion. On one hand, nimble companies who are most able to adapt to changing business environments often achieve the greatest rewards; however, operating efficiency, which includes limiting expenses like lease payments, also contributes to profitability. Ultimately, the lease decision is one more example of an important factor dependent on the strategic direction of the firm. Suffice it to say, that the space you commit to in a lease will either limit or enhance your achievement of your strategic goals.

In conclusion, "How much space are you looking for?" is not as simple a question as it may seem. The answer depends on more factors than one might expect. However, with the consequences of a bad decision as dire as they are, careful consideration is warranted. Competitive analysis, budgetary analysis, demand analysis, and strategic analysis will provide insight into finding the answer to this question, resulting in a lease which is appropriate to the amount of space your company needs.

Dan Oster is an associate for the Industrial Properties Group of Alliance Commercial Real Estate and holds a master's in business administration from the University of Nevada, Reno. Contact him doster@alliancereno.com.