Residential leases are much easier for real estate agents than commercial real estate leases are. That’s because these kinds of contracts call for a rent amount that doesn’t change from month to month. Unfortunately, this doesn’t hold true with commercial leases, which can be mind-bogglingly complex. One reason for this is a little something called rent escalation clauses.
Nowadays, many commercial leases include one.
One of the most widely used type of rent escalation clause are those based on operating expenses. These are costs like trash removal, janitorial expenses, insurance fees, heating, air conditioning, and security. If you have a clause like this in your lease, your rent will go up if operating expenses increase relative to what they were in a pre-agreed upon base year.
Some commercial tenants feel their lease rate should be like residential lease rates—staying the same from year to year. However, with ever-increasing operating expenses, the landlord would be losing quite a bit of money if he couldn’t include rent escalators in the rental contract.
With a rent escalator, what you pay to lease the space will either increase on a predetermined schedule or in response to a specific trigger. One such trigger is the Consumer Price Index.
The Consumer Price Index is a measure that examines the weighted average of prices of a basket of consumer goods and services. It’s calculated by taking the price changes for each item in the basket and averaging them.
When you’re negotiating a lease agreement, you should keep the escalation factor as low as possible. That’s because, like other costs based on percentages, rent escalation compounds. This means that over time, the amount you pay can spiral out of control.
Rent escalation clauses come in a few different forms. Some call for a single payment that charges a fee for the use of the space as well as for the cost of managing that space.
Others have separate charges for the rent and the operating expenses.
Your lease should spell out exactly how rent escalation will be calculated as well as a precise schedule of the increases. Usually, the rent escalator kicks in on a yearly basis.
Although it’s only fair to let you landlord put one of these clauses in your lease, you don’t want these expenses spiraling out of control. That’s why you should try to negotiate an expense stop, so there’s an upper limit to what these charges can be. Sometimes, landlords are reluctant to negotiate a ceiling to those things they have no control over—like real estate taxes or insurance premiums.
This is perfectly understandable, although he should be amenable to agreeing to a cap on all expenses that are more easily controlled. These are things like snow removal, lawn care, and building maintenance costs.
Without a cap to how high these expenses can go, a shady building owner could hire friends who are equally as unethical to perform work at ridiculously inflated prices. And, he could pass these costs along to the poor tenants—profiting handsomely off their backs as a result.
When you’re considering whether to lease a property, always look carefully at any rent escalation clauses. You must make sure that their presence is fair and equitable to all parties.