If you rent a commercial office space in Manhattan, your lease will have an escalation clause.
In an escalation clause, your rent increases annually. The landlord’s only option is to recoup rising building services, personnel, energy, and building maintenance costs this way.
Primarily because these costs increase year-over-year at a pace that matches or exceeds inflation.
How Much More Per Year?
Commercial landlords use different methods to calculate how much they will increase your rent.
Fixed Annual Percentage Increase (Most cCmmon)
Your rent goes up by a fixed percentage every year for the term of your lease: usually 3% per year in New York City. From a tenant’s perspective, the advantage of a fixed annual rent increase is that your future rent payments are entirely predictable.
Consumer Price Index
When landlords increase rents by the consumer price index (CPI), they determine rent increases by the inflation rate. Of course, rent escalations in this manner are unpredictable. It can reduce your real estate costs if the CPI is low for your lease term. On the other hand, if inflation ramps up, you could pay more rent than you would with a fixed percentage increase.
Tenant’s Proportionate Increase in Operating Expenses
A landlord could also link rent increases to a tenant’s proportionate share of how much an entire building’s annual operating expenses increase over a base year.
For example, say your space equals 1% of a commercial building’s square footage. If the building’s operating costs increase by $10,000 over the base year, you’re on the hook for a $100 rent increase.
Alternatively, if operating costs for the building don’t go up, your rent will not increase.
This type of annual rent escalation is most common in upscale, well-run Class A office buildings. These buildings are usually efficiently run and the annual escalation is often modest. While it can be advantageous for tenants, the disadvantage is that annual increases can be unpredictable, particularly when inflation exceeds historical norms.
5+ Year Leases Often Have “Bumps”
Commercial tenants with leases exceeding five years often pay a fixed fee or a “bump” halfway through the lease. This comes on top of one of the above rent escalations.
The timing and amount of a “bump” can be negotiated to reduce the financial impact. Generally, “bumps” are more negotiable than annual percentage increases.
Don’t Overlook Tax Increases
New York City commercial leases also hold tenants responsible for paying their share of real estate tax increases assessed on a building. The more space you occupy, the greater your tax increase. However, remember that real estate taxes do not always increase annually.
Ask Your Broker for a Projection of Annual Rents
Understanding what your rental payments will be during your lease term is a complex matter. It is important to clarify how escalations get calculated in each building with your broker. To determine your total liability, ask your realtor to provide a projection for future rents that factor in all escalations and miscellaneous increases.
