What Is Rent Expense?
Rent expense is the cost incurred by a business to utilize a property or location for an office, retail space, factory, or storage space. Rent expense is a type of fixed operating cost or an absorption cost for a business, as opposed to a variable expense. Rental expenses are often subject to a one- or two-year contract between the lessor and lessee, with options to renew.
- Rent expense is the cost a business pays to occupy a property for an office, retail space, storage space, or factory.
- For a retail business, rent expense can be one of its biggest operating expenses along with employee wages and marketing costs.
- For manufacturing companies, rental expenses tied to production are part of factory overhead, while administrative office rent is part of operating expenses.
- A factor that can impact rent expenses includes the need for a location near a major metropolitan area, ports, or transportation lines.
- As more people shop online, many retail companies have shifted the money they previously spent on rental expenses to support e-commerce instead.
Understanding Rent Expense
Depending on the type of business, rent expense can be a material portion of operating expenses or a negligible one. For retail businesses that do not own their own property, rent expense is one of the main operating expenses along with employee wages and marketing and advertising costs.
Manufacturing companies typically spend low amounts in rent expense as a percentage of total expenses. Rent expenses for manufacturing operations are included in factory overhead, while rent not tied to production—i.e., administrative office space rent—is charged to operating expenses. In real estate, location is usually the most important factor in the price of rent.
A retailer that wants to set up in a prime area with heavy foot traffic will have to pay higher rent expenses than for a secondary location. A manufacturer that wants to lease factory or warehouse space close to ports or transportation lines in major metropolitan areas would face higher than average leasing costs. Rent expense consideration is balanced against the benefit of being in a prime area, for the retailer, and of being close to transshipment points, for the manufacturer.
The increase in the popularity of e-commerce has led many companies to rethink the amount of money they spend on renting commercial real estate. Some companies are reducing the number of brick-and-mortar stores they operate to shift more of their operations to online shopping. "Click and mortar" describes the business model where retailers combine online and offline operations in the form of a website and physical stores to meet consumer demand.
The demand for office space is also changing due to technological advancements as companies realize they can employ workers remotely from home. An obvious benefit for the company is a reduction in property rent expenses, while many employees say they prefer the convenience of working from home.
Real World Example for Property Rent Expense
The property rent expenses for retailers can fluctuate depending on a variety of factors, such as the state of the economy. For example, Signet Jewelers Limited (SIG) operates a chain of shops nationwide under Kay Jewelers, Zales, and Jared brand names. In 2017, the company disclosed in a note to its financial statements in the 10-K filing that some of its operating leases include predetermined rent increases. The increases are charged to the income statement on a straight line basis over the lease term, including any construction period or other rental holidays.
Contingent rentals, taxes, and common area maintenance are charged to the income statement as incurred. Contingent rentals—amounts based on a percentage of sales in excess of a predetermined level—are separated from minimum rent until the company can determine when it is probable that the expense has been incurred and the amount is reasonably estimable. In the fiscal year 2017, Signet incurred minimum rent expense of $524 million and contingent rent expense of $10 million, or approximately 28% of total operating expenses.
In June 2020, however, Signet announced it would begin to significantly reduce its property rental expenses due to the financial impact of the COVID-19 pandemic, which required the company to temporarily close its brick-and-mortar stores worldwide. The company reported same-store sales plummetted 39% over the previous year. Total sales in the North American segment declined 39.9% and sales in the International segment fell by 41.2%. The one bright spot for the company was that over the same period e-commerce sales increased by 37.2%.
The company announced its plans to permanently shutter hundreds of stores, many in shopping malls, as part of its reorganization strategy to reduce its footprint by 20%. Signet says it will enter renegotiations with landlords of their remaining mall stores, actively seeking concessions on rent payments. The company will accelerate its efforts in digital jewelry shopping, continuing to engage customers at home through video technology to conduct virtual by-appointment shopping consultations.