Dec 092012

What Is A Fair Annual Increase In the Rental Rate For A Commercial Lease?

By Steven Silverman, CCIM   Tampa Commercial Real Estate
It is often a bone of contention between Landlord and Tenant what the annual rate of increase in the lease rate should be on a commercial lease.
I have a situation right now where a Letter Of Intent has been presented by a tenant. The landlord wants an annual percentage increase in the lease rate of 3%. The Tenant is demanding a flat lease rate for the entire first term. Then at the end of the first term they would accept a lease rate increase for the second term, which similarly would be fixed for the duration of second lease term.  The Tenant believes that not only should there be no increases in during the lease term, they also feel that the landlords request for an  annual 3%  increase is highway robbery because in the last few years rate of inflation has been much lower than 3%.
The tenant’s sentiments were expressed in an  email “our finance people don’t agree to  spread out the increases annually of over the  term of the lease because with the annual increase requested by the Landlord, the lease rate of would be astronomical at the end of our first term and the 2nd n 3rd term of the lease would be unaffordable. This is not smart business.”

One solution be to have an annual increase, but peg the increase in the consumer price index. This way, if the CPI increased by only one half of one percent, then the lease rate would increase by only one half of one percent.
The landlord and the tenant are both frustrated with each other. Landlord requested me to research what a fair rate of increase in the lease rate would be.  I went back and doing research on the historic inflation rate in the United States which is reported by the Bureau of Labor Statistics.
• From 1914 to 2012, the inflation rate in United States averaged 3.4%.
• However, between the year 2002 011 the inflation rate was only 2.55%. This is an average.  In 2009 for instance the rate of inflation was actually -0.3%. The Tenant may well argue that in this year their lease rate of should decrease.
• Between the years 1968 and 1982 the average inflation rate was 7.38%. However, this is also an average. In some years, the inflation rate was much higher. In 1980 the inflation rate was 13.6%
In reviewing the historic statistical information is clear that the landlord’s proposal of an annual 3% increase in the lease rate is fair. It is lower than the historical long-term rate of inflation. If there as an annual adjustment factor of the lease rate the claimant would be very happy in 2009 when their rent would have decreased. However they would not be so happy if it were 1980 and their lease rate increased by 13.6% in one year.
The Tenants proposal of a flat rate of entire lease term of the is unfair. It would be interesting to see if that tenant would agree not to raise prices on the products and services that they sell to their clients during the first lease term.  To do this , they probably  also have to get their staff to agree to flat wages during that same period and get their suppliers to hold prices to todays level.
Using the consumer price in  the annual adjuster of the lease rate a is a double-edged sword.  Inflation is a real and it is not going away. If a business needs to take care of inflation in a predictable manner, it seems that the 3% rate of increase is a fair compromise. In fact, it is more to the benefit of the Tenant. It is hard to believe that the current low rates of inflation will continue given the amount of borrowing undertaken by the USA. It would not be surprising to see inflation rates return some years down the road. The tenant has the opportunity to limit their risk of lease rate increase to 3%.

  5 Responses to “What Is A Fair Annual Increase of the Lease Rate For A Commercial Lease?”

  1. Your information is very much valuable to me; however, I would appreciate to give me an example on how to calculate such increase using ur formula in the the following scenario:

    My commercial property is located in Long Beach, CA and it will be used as a seafood restaurant. Lease payments will be $3000 monthly for 4 years . How much can I increase under your method?

    Thanks a lot for your cooperation,

    • So if you are doing 3% annual increases which is generally accepted in our market
      First year = $36,000 per year = $3,000 per month
      Second Year + $37,080 per year = $3,090 per month etc

  2. If the lease is triple net and the tenant is already paying for all of the operating expenses, why should there be an annual increase in rent? Any increases in operating expenses due to inflation are already paid by the tenant.

    • I argue this point with landlords all of the time but have yet to get rid of the escalators. I achieve reductions in the rate for my clients but have failed to eliminate the escalator entirely. I believe an all out blitz on base rent escalators by all NNN tenants is needed to change this unfair practice. There is no justification for increasing the base rent when the tenant pays actual CAM expenses. The base rent increases directly increase landlord profits, nothing else. Profits should not increase for doing nothing. Escalators are a rip-off.

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