When you calculate the rental value of retail property, you tend to use a specific form of measurement called ‘Zoning’, which uses an 'ITZA' rate to formally acknowledge the unique way in which a retail property’s shop floor works for a retailer.
CLICK HERE to immediately download a 10 point Fact Sheet explaining how Zoning and ITZA benefit retail properties.
Before we go into what this means, here is a quick video summary of what's included (with slides available here).
Start With The Actual Area
It originated in the 1950s and a now a mainstream reference used by property surveyors when talking about how valuable a retail shop is and what rent a tenant should pay, particularly for those on High Streets where trade depends upon people walking by and deciding whether to shop at the property.
The actual measurement of the property is still the same as other properties, in that you are measuring whatever areas in either imperial feet and inches or metric metres and centimetres.
You should really use modern metric forms, although reference is often still in square feet in terms of areas and rental values.
So whilst this technical aspect of measurements is the same as other properties when it comes to this separate retail zoning measurement and effect, then it’s all about how you then tweak these final measured areas.
A Retail Zoning Example Shop Floor to Explain
Let’s assume you have a newsagent shop facing onto a busy high street, 30 feet wide and 60 feet deep. In simple terms, the total area is 1,800 square feet as you times one by the other, and so if the going rate is £10 per square foot, then the total annual rent is £18,000 pa.
So the end rental value of this and, in fact, most mainstream commercial property is derived from literally how much area you have of usable space as a tenant and then applying a similar rate per square foot.
Therefore, you often hear reference to the going rate per square foot in an area, designed to explain what a generic rate is that needs applying to the actual amount of area that each property has to end up with an end rent.
But retail property arguably has its most important space right at the front of the shop, where most people will see items for sale as soon as they enter the property - after they first see-through any shop front window from the street.
So with a lot of newsagents and shops, they will tend to have lots of important stock right at the front of the shop on display, to leave the less essential goods and operations like the till and changing rooms further back in the shop.
You don’t tend to see this dwindling-value factor in other property types and less shopper-focused uses. So if you have a small industrial unit storing items that you sell online, you may have a standard rate of £5 per square foot of industrial space, with the whole area attracting the same rate across the entire property.
But with retail property, if a retailer had a choice, they would pay additional front space to easily sell items rather than lots of wasted space at the back of the store that shoppers tend to walk less into.
So if we divide the above example newsagent shop floor into three sections going backwards, these will all be still 30 feet wide but 20 feet deep each. The first part will be most beneficial, the last section least helpful, and the middle one somewhere in between. You can then label these alphabetically going backwards, so the front section A, middle B, and rear section C.
Here is a good video from the VOA explaining some of the technicalities of these ITZA calculations.
The Principle Of Zones & Zone A Rate
This is actually what Zoning prescribes, literally 20 feet deep sections going back that theoretically halve in value every time you move into the next section.
So the rate per square foot of the second is assumed to be only half as valuable as the first one. The final area C has then halved again, i.e. half of what area B is, or to put it another way, one-quarter of what the original area A was.
These are all known as Zones and are standard 20 feet deep sections of space assumed to halve in value every one going back. Therefore, a surveyor will need to divide their areas up into these different Zones, with the first Zone A space being 600 sq. ft in this example, the next Zone B being 600 sq. ft., and in fact, the final Zone C being another 600 sq. ft.
This initial Zone, A area, is crucial and has the main ‘Zone A’ rate applied to it, let’s say £10 sq. ft. again in this example.
The Principle of the ITZA
When looking at the rest of the areas, though, for convenience, a tweak is made to these areas and not the initial main Zone A rate.
So instead of halving the actual rate for different zoned areas, you bundle all the areas back together after an adjustment to keep things simple mathematically and times it all by the same Zone A rental rate.
You, therefore, end up with a deliberately unnatural and skewed version of the original areas so that you can times the same Zone A rate to it to have this Zoning effect rolled out.
Put another way, you divide the areas by two instead of the multiplier by two to end up with the same effect. So you stick with Zone A of 600 sq.ft., but then halve this to 300 sq. ft for an adjusted Zone B area. Also, halve again to 150 for the Zone C area. Finally, add all these together to establish an ITZA area of 1,050 sq.ft, which is lower than the original 1,800 literal area.
So when you add the £10 rate to this adjusted ITZA rate of 1,050 means, you get £10,500 pa rather than the original £18,000 on the original area, which has taken into account the fact that Zones B and C are less valuable space than the £10 rate for the front Zone A area.
To then finish things off, surveyors and valuers can apply a discretionary adjustment to the end rate to ensure that the final ITZA rate reflects the reality of how any one retail property is laid out and shaped. This is separate from how you apportion the rent anyway over time in the lease or after, say a rent review, often on a quarterly in advance basis.
So one example and adjustment are called the Frontage to Depth ratio, where the standard 20-foot zones cannot fully appreciate an unusually long and narrow shape or wide and short.
Or another is Return Frontage zoning for, say, a corner shop that has a shop front along the side and front elevation, so some of the Zone B and C spaces will benefit from Zone A exposure. You may also need to look at how masking affects the retail zoning effect.
Whatever is agreed, it’s often a final percentage uplift or decreases on the rent after the main ITZA calculation.
The Zoning Effect
So this is the theory of the Zoning effect for retail properties. Therefore a form of definition for ITZA and retail zoning is the ability to alter the area to a smaller area artificially and still apply the front and the main Zone A rate per square foot to arrive at a reduced but fair rent.
This accounts for the fact that space at the rear of a shop is less valuable than the rest.
In reality, it’s often just the ground floor area treated in this way, often to just Zones C or through to D and E before a generic rate is applied for the remainder.
This is in addition to other standard rates for each floor of the shop, and rear storerooms, which again tends to reduce in value the further up you go as the difficulties of additional steps to walk to collect upper-floor storage area is reflected in the overall retail rent (helpful when also looking at property asset management opportunities).
However, you may still need to apply retail zoning on the first floor or other areas depending upon footfall for popular stores.
Even with this basic understanding of Zoning, because you’re dealing with such significant rent figures, it’s worth instructing or at least discussing with a surveyor who knows this principle in the reality of the local property market to make sure that any figures being agreed are reflecting reality and the actual market values.