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What A Dental Real Estate Tenant Needs To Know About Rent Escalation Clauses (Part II)

What A Dental Real Estate Tenant Needs To Know About Rent Escalation Clauses (Part II)

6/19/2019 7:26:11 AM   |   Comments: 0   |   Views: 25

Types of Rent Escalation Clauses

There are a couple of types of rent escalators:

Stepped Rent Escalation Clauses

This type of rent escalation allows your landlord to increase your rent at specific intervals. For example, you might pay $30 a square foot in year one, $31 in year two, $32 during year three, and so on.

While many landlords like small annual increases, longer-term leases (especially those of 20 years or more) may have more substantial hikes spread out, like a 10 percent increase every five years.

This type of rent increase favors tenants because it eliminates uncertainty over what you'll be paying over time.

Escalation Clauses That Depend on A Specific Trigger

With this type of clause, your rent only increases if the landlord experiences an increase in costs as specified in the contract. These increases are always tied to triggers.

If the trigger for your escalation clause is property taxes, you'll pay more if your landlord's property taxes go up. Because property tax increases usually aren't wildly unpredictable, this type of escalation shouldn't affect your practice too much.

One of the more popular pass-through escalation clauses is tied to direct operating cost. Since operating expenses fluctuate, the landlord has a way to offset such costs by passing some of them onto the tenant.

Operating expenses can include utilities such as heating, air conditioning, security, and maintenance. 

Indexed Escalation

With this type of escalator, your rent rises in lockstep with the Consumer Price Index (CPI). 

It's difficult to predict the movement of the CPI. And, changes can be sudden and dramatic. That's why this type of escalation is usually the worst for tenants. 

If your rent is tied to the CPI and inflation spikes, what you pay for rent will skyrocket. However, if you're able to cap the amount it can go up, you'll eliminate much of the sting from this kind of escalator. 

In times of high inflation, your rent goes up—but not too much. And when the cost of living is low, you end up with little to no rent escalation to worry about. 

Some landlords entice a tenant to sign a new lease by capping the amount of rent escalation. Or, agree not to require one until the second year of a tenancy. 

Unfair Use of Rent Escalators

Rent escalators are a good thing because if they're used in the way they were intended, your landlord is ensured of a fair profit.

However, some landlords abuse these clauses as a way to fatten up their coffers on your dime. Because there are so many ways to figure out operating costs, there's enormous potential for a landlord manipulating the numbers to gouge you.

For example, actual operating expenses increase by about 2.5% to 3% per year. Unscrupulous landlords will calculate your rent escalator based on the entire base rent and not just the portion of that which is operating cost.

The base rent may be $50 per square foot. The portion of that $50 allocated to operating expenses will be about $13 to $18. But the landlord gets an increase based on the entire $50 per square foot, which means you'll be paying more than your fair share.

Be aware of this practice, so when it comes time to negotiate, your tenant rep can speak up for you.

Sometimes rent escalation clauses are tied to the Consumer Price Index. However, this doesn't necessarily correlate to increases in what it costs to operate the building. It could be less, or it could be more.

Rent escalators triggered by increases in the building's operating expenses are more accurate. However, it can be difficult to agree on what constitutes these costs. It's easier to calculate an annual fixed rate than those based on operating costs or an index.

Have your broker negotiate for better terms if the rent escalation clause in a lease you're considering signing seems unfair. Offering a longer lease time or compromising on things that don't really matter could help you come to an agreement that's more beneficial for you.

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