Craft Strategic Rent Escalation Plan

In a perfect commercial real estate world, shopping center and retail leases wouldn’t be subject to variables that could negatively affect your profitability. In reality, inflation—which is impossible to predict with complete certainty—can affect your bottom line unless you and the tenant agree to use “rent escalation” to keep up with the market. This isn’t as simple as it sounds, though. There are several methods that can be used to do this, and pros and cons for each. The one that your tenant suggests during negotiations might not be the best choice for you. But you also need to keep in mind that a tenant could be nervous about agreeing up front to rising costs later. So pay close attention to this part of your lease deal. Before negotiating and drafting your rent escalation provision so it’s favorable to you and fair for the tenant, do the following:

Realize importance of keeping up with costs. Rent escalation might be on the back burner if seemingly more valuable items—like cotenancy clauses and exclusive use rights—are up for negotiation with your tenant. But if you agree to the wrong rent escalation formula, that mistake can be costly and last the entire life of a lease, potentially leaving you with having to make up the difference between inflated costs and what the tenant is obligated to pay as escalated rent.

Understand methods for keeping pace with inflation. So how can you use a rent escalation clause to your advantage? There are three common methods of escalating rent. Your attorney can help you choose wisely and according to your specific lease deal.

• Use consumer price index
• Use costs
• Use fixed percentage

For a detailed explanation of how these methods work and the ideal situations in which to use them, plus Model Lease Language to help you do so, see “Ensure Favorable Rent Escalation for Life of Lease,” available to subscribers here.