Many commercial leases include some type of rent escalation clause, which allows the landlord to increase the rate of your rent either on a specific timeline or in response to a specific trigger. There are a number of types of rent escalation clauses used in commercial real estate lease agreements.
Here are some of the most common:
1. Percentage Increase Escalation
Percentage increases are fixed, and they go up by a set percentage rather than dollar amounts. This escalation type will allow your organization to accurately assess its operating budget upon signing for years to come. When negotiating your lease with your landlord, you will come to an agreed percentage amount that your rent will escalate throughout the term of your lease.
2. Stepped Increase Escalation
With a stepped increase, the amount of your lease will increase periodically a pre-determined amount. For example, your rental rate may increase by $1 per square footage per year. In this example with a five-year lease, you might pay $17 per square foot for year one, $18 for year two, $19 for year three, $20 for year four and $21 for year five. Stepped increases are beneficial for tenants, as they give you a clear picture of what your costs will be over time.
3. Tax Pass-Through Escalation
With tax pass-through rent escalation, your rent will increase only in the event that the landlord's property taxes increase during the term of your lease. In this type of agreement, you will usually be responsible for paying a percentage of the increase based on the amount of space that you occupy.
4. Direct Operating Cost Pass-Through Escalation
This type of rent escalation is similar to tax pass-through escalation, except that your rent increases when operating expenses like heating, electricity, maintenance and security go up in cost. It is vital that this type of escalation clause clearly spells out what is and is not classified as an operating cost.
5. Indexed Escalation
Many commercial real estate lease agreements have indexed rental escalation clauses. These clauses are usually tied to the Consumer Price Index released by the U.S. Bureau of Labor Statistics. If the CPI increases, your rent will increase accordingly based on the rate of inflation. This type of rental escalation can be very unpredictable and lead to dramatic increases in occupancy costs.
As you can see, some rent escalation clauses are more favorable to tenants than others. Having a commercial tenant representative by your side during the negotiation process can give you an edge when trying to encourage your landlord to choose a more favorable method for determining rent escalation.
Even after you have signed the lease, it's important to keep an eye on rent escalation. Your rent will remain fixed until you reach a base year outlined in your contract. At that point, it is a wise idea to have a commercial real estate attorney audit your lease to ensure that the rent escalation is calculated accurately and fairly.
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