Check out Part 1 & Part 2 in case you missed them.

In this part we will cover the critical lease clause is the rent escalation clause.  This clause is often the focal point of landlord-tenant disputes so we will discuss some ways to avoid any conflict and save some money in the process.  Rent escalation has become all but a standard in commercial real estate and the idea of fixed rent is now seen as lease provision more than anything else.  In order to hedge any price increases you will want to do two things: consider the market and get a clear definition of what is to be included in your rent.

Considering the Market

Tenants typically pay at an escalation rate of up to 3%, compounded annually.  This yearly increase usually takes place on the anniversary of your lease commencement date.  What a landlord will often do is seek an annual increase based on the Consumer Price Index (CPI).  In this situation, you can avoid excessive escalations by applying a cap on each years increase (e.g. no more than 3% or $5,000 per rent cycle).  Another way to do so would be negotiating a delay in price increase, say not for 3 years in a 10 year lease.  These adjustments to your occupancy cost could have a significant impact on your bottom line.  Make sure that, in your negotiations and competitive bid processes, you remember this aspect of your site selection.

Defining Your Lease Terms

Your lease should tell you exactly what you are getting in consideration for your tenancy dollars.  This begins with the actual space you have absorbed.  References to space and square footage should not only be explicit, but accurate.  It is surprising to see how many leases describe the space in question with mere estimations in terms of square feet.  For example, if your currently renting 19,750 square feet of office space at $25 per square foot, but your lease rounds to a flat 20,000 square feet, that is an extra $6250 you are paying out of pocket for space that doesn’t exist in the first year alone.  Consider that with your annually compounded escalations, and you could be looking at substantial losses over the duration of your lease.  Be sure to measure your unit and see to it that your lease reflects your accurate and precise measurements.

You will also need to know what is to be included in your rent.  Click here for a quick overview of the basic lease types and what they really mean for your occupancy cost.  With this information you will have a better understanding of what it is you are paying for and why an escalation is or is not fair for the tenant.  Landlords are looking to “pass through” as many costs onto the tenant as possible for greater profit margins.  But consider a situation in which you are already paying repairs, maintenance, and other basic operating expenses separately from your base rent. 

A rent escalation in this case would lead the tenant to make adjustments for inflations and the like twice – once in your separate operating expenses and once in your base rent escalations.  Be cautious in your agreement and make sure that you are analyzing every concession and provision of your lease.  There may be expenses you never realized you have already covered, or better yet, never had to cover in the first place.

Read Part 4

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