What is a fair rent increase? My firm is negotiating a lease on an industrial building, and the landlord is asking for a 5% escalation every year. Is there a standard rent increase for industrial leases?
There are no standard or published lease escalations. Escalation terms are essentially whatever two parties can agree upon. An alphabet soup of rent escalators was common in the past, such as CPI (consumer price index) and COLA (cost of living adjustment). A more esoteric means of measuring the supposed cost of landlord costs was called Porter Wage (with and without fringe benefits.) This tied a tenant’s rental increase to the rise in the cost of hiring porters in New York City. Most of these lease escalators have fallen by the wayside, and what is most common today is a simple percentage increase in the rent, usually on the anniversary date of the lease commencement.
There are some guidelines that reflect the current negotiating trends in the marketplace. A typical rent escalation today is often a 3% to 4% increase in the net rent each year. This can vary however, depending on the term of the lease (longer terms such as 20 years will either have lower annual increases, or the “bumps” will be spaced further apart, e.g. a rental increase every three years.) The financial strength of the tenant, or the market demand for the space, will also play a role in the ultimate rent escalation. The landlord is attempting to anticipate, and collect rent upon, the rising value of his real estate. The tenant is, obviously, attempting to control costs. This is one reason that open ended lease escalations, such as those based upon a consumer price index, lost favor. They made it impossible for a tenant to cap his rental increase.
However, there is one clause in almost every lease on Long Island that does allow for an open ended increase. Almost all tenants face either a “tax stop” clause, or a provision in the lease requiring direct payment of the real estate taxes by the tenant. A “tax stop” clause provides that the tenant will pay his proportionate share of real estate tax increases in a lease where the landlord is responsible for the payment of base year real estate taxes. Either way, the tenant is responsible for real estate tax increases, a cost that cannot be predicted with absolute accuracy.
As a tenant, you want to make sure that your rental increase is calculated on the net rent (rent without real estate taxes), not the gross rent. If your rent is being quoted as a gross rent that includes real estate taxes, insist upon knowing the actual portion of the rent allocated to the taxes. Your escalation should be based upon the gross rent less this allocation. Otherwise you will effectively have two real estate tax escalations.
Your broker should be able to provide you with guidance on recently negotiated deals with this landlord, or landlords of similar properties. A little homework and education will go a long way to making sure that your escalations are reasonable and not above market.
David G. Hunt, MCR, CCIM, SIOR is the president of Hunt Corporate Services, Inc. and has provided commercial real estate services on Long Island, New York since 1973. To contact Mr. Hunt, please email firstname.lastname@example.org, visit the website at http://www.huntcorp.com or call 516 937-1000.