When you sign a commercial lease, you are agreeing to pay rent in a certain amount to occupy space in a building and pay for the maintenance required to keep common areas in good condition. That doesn't mean that you'll be paying that exact amount over every year of your lease. Most commercial real estate leases include rent escalation clauses that allow landlords to raise rents in order to keep up with inflation or cover operating expenses.
Read on to learn what you need to know about these clauses.
1. Rent Escalation Clauses Are Not Always Linked to Operating Costs
As mentioned above, rent escalations are not always associated with operating costs. Landlords may opt to raise rent annually in order to offset the cost of inflation. With these types of rent escalations, the lease will specify when the increase will occur and how it is calculated.
2. Actual Rent Clauses Can Be Fixed or Variable
Rent escalations that are tied to actual rent can be fixed or variable. Fixed rent increases are often referred to as stepped increases. With this structure, the landlord increases your rent by a specified amount at specific points during your lease, such as every year or once every three years. The increase is usually based on square footage, so your rent could go from $20 per square foot to $22 per square foot.
Variable increases are called indexed increases. Typically, these increases are tied to a third-party indicator like the Consumer Price Index. As the index changes, your rent increases in the same amount. With this type of rent escalation, a cap should be put in place to protect tenants from sky-high sudden increases.
3. Operating Cost Escalations Can Be Handled in Different Ways
As with actual rent increases, operating cost-associated rent escalations come in different forms. With pass-through escalations, your rent increases only when certain costs for the landlord increase. Normally, these types of rent escalations are only triggered by property tax increases. Direct operating cost pass-through escalations allow landlords to pass along any increases in operating costs, such as security and maintenance. This type of rent escalation can prove very costly for tenants.
4. You Could Owe More CAM at the End of the Year
In some cases with direct operating cost pass-through escalations, landlords calculate a budget for common area maintenance fees at the beginning of the year. The fees are based on estimated costs and then divided among the tenants in amounts that correlate to the amount of the building that they occupy, respectively. At the end of the year, the landlord could have the right to demand a payment from you to cover any shortages. On the flip side, you could receive a refund if you overpaid.
5. Always Calculate Escalations Yourself
No matter what type of rent escalation is stipulated by your lease agreement, it is important that you take the time to calculate increases on your own. If you can't arrive at the same figure as your landlord, ask to be shown exactly how the increase was determined.
Most importantly, make sure you have an experienced tenant rep on your side!
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