Like death and taxes, there are certain expenses that can’t be avoided. For instance, if you you have a New York City office space rental, your commercial lease is going to have an escalation clause and your rent will increase every year. There is no getting around that.
To understand why this is inevitable, place yourself, for a moment, in a landlord’s shoes. Because the cost of building services, personnel, energy and building maintenance go up every year at a pace that matches or exceeds inflation, a landlord’s only option is to recoup increased costs by adjusting rents.
How Much More Per Year?
Landlords will figure out the amount of the increase in different ways.
–Fixed annual percentage increase (most common)
Your rent goes up by a fixed percentage every year, for the term of your lease: usually 3% per year in New York City. The advantage of this form of escalation is that your future rent payments will be completely predictable.
-Consumer Price Index
If the inflation rate remains low for the term of your lease, the CPI escalation can save you money. If, on the contrary, inflation ramps up, you can end up paying more rent than you would with a fixed percentage increase. Be aware that with this formula you cannot predict what your future rent will be.
-Escalation Based on Tenant’s Proportionate Share of Increases in Operating Expenses
In this scenario, annual rent increases are linked to a landlord’s cost of operating a building over a given “base year” (the first year of your lease). So let’s say your space equals 1% of the entire Square Footage of a commercial building. Suppose the cost of running the building goes up $10,000. As a tenant you would then be liable for a $100 rent increase. Alternatively, if operating costs for the building don’t go up, your rent will not increase.
Landlords of Class A buildings that use this formula generally take aggressive measures to keep their costs down, so this it can be very favorable for tenants. But like for the CPI escalation, you cannot precisely predict future rent liability.
Leases Exceeding 5 Years Often Have “Bumps”
Customarily, in commercial leases exceeding five years, landlords require a fixed dollar amount increase in the rent in addition to the percentage or CPI annual increase. This is called a “bump”. The timing of the “bump” is typically midway thru the term of the lease. For example, if you sign a 10 year lease, you may be faced with a “bump” in the 6th year of the lease.
The timing and amount of a rent “bump” can be negotiated so as reduce the financial impact on a tenant. Generally “bumps” in the rent are more negotiable than annual percentage increases.
Don’t Forget the Impact of Real Estate Taxes!
Note that New York City commercial leases also hold tenants responsible for paying their proportionate share of real estate tax increases assessed on a building. If you occupy a small percentage of the entire building, your liability will be limited. Also keep in mind that real estate taxes do not necessarily increase every year.
Ask Your Broker for a Projection of Annual Rents
Understanding what your rental payments will be during the term of your lease is no simple matter. It is important to clarify with your broker how escalations get calculated in each building. For you to determine your total liability, ask your broker to provide you with a projection for future rents that factors in all escalations and miscellaneous increases.