When you sign a lease to use an office space or building for a specific term, it's important to understand that your rent will likely not be fixed over the entire term. Many leases include rent escalation clauses that allow landlords to increase the price of your rent over time. These tips will help you understand escalations and deal with them:
1. Make Sure That You Understand the Type
There are four main types of rent escalations:
Stepped Increases
This type of rent escalation allows landlords to increase the amount of your rent by a set amount at specific points during your lease. As an example, you may pay $20 per square foot during year one, $21 during year two, $22 during year three and so on. This type of increase is favorable for tenants, as it makes it possible to anticipate future costs.
Pass-Through Escalation
With this type of clause, your rental rate increases only if the landlord experiences an increase in costs as specified in the contract. Typically, the escalation is triggered by an increase in property taxes. When the escalation occurs, you are assessed an increase based on the percentage of the building that you occupy. Although the increase is not predictable, this type of escalation may never affect your business and is generally more favorable than some other options.
Direct Operating Cost Pass-Through Escalation
Like the pass-through escalation, this type of escalation occurs only when operating costs like utilities, security and maintenance increase. Your rental increase is based on the amount of the building that you occupy. The lease should specify exactly what costs are included in the calculation. This type of escalation is more likely to impact businesses, and cost increases can be very unpredictable.
Indexed Escalation
With this type of escalation, your rent rate increases when an established index rises. Often, the index used is the Consumer Price Index, which is published by the U.S. Bureau of Labor Statistics. Because it can be difficult to predict the movement of the CPI and changes can be sudden and dramatic, this type of escalation is generally the least favorable for tenants.
2. Do the Math Yourself
When it comes time for your rate to increase, sit down and do the math yourself. Make sure that the number that you come up with matches your new rent rate. Don't assume that the landlord has calculated things correctly. If you discover a discrepancy, ask for clarification.
3. Plan for Increases
Depending on the type of escalation specified in your lease, you may not be able to determine exactly what your new rental costs will be; however, it's important that you still budget accordingly in anticipation of an escalation.
4. Use Your Negotiating Powers
If the rent escalation clause in your current lease or a lease that you are considering signing seems unfair, renegotiate or negotiate for more favorable terms. Offering an extended term or forgoing concessions that are not important to your company could help you to negotiate a more favorable schedule.
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