I enjoy working with business owners and leaders to secure a great location and negotiate a fabulous rent rate for the best space for their business. However, unbeknownst to many tenants, the rent rate is only one of the financial aspects involved in leasing commercial real estate. Additional costs that come into play are often tucked into the lease document. Potential wallet munchers, which can be scary if not addressed properly, include:
- Rent escalation
- Pass through expenses
- Holdover rent
Common in commercial leases, rent escalation clauses are designed to protect the landlord’s net rent against inflation by increasing the base rent rate, usually on an annual basis. This increase can be calculated using a variety of methods. Negotiating a specific increase – either a monetary amount, a set percentage figure or a percentage of a consumer or other price-type index – with a cap on the amount of the increase, are helpful in containing this cost. Knowing the market and including clear language in the lease helps to keep this cost in check.
Regardless of the type – net, modified gross, full service – commercial real estate leases will likely include a clause for the pass-through of expenses related to the operation and/or maintenance of the building and common areas. Landlords estimate the costs for operation and maintenance of their buildings each year.
For full service and gross leases, these operating expense estimates are usually included in the negotiated rent rate for the base year.
For net leases, the tenant pays the estimates for the taxes, insurance and common area maintenance (TICAM) in addition to the rent.
Regardless of lease type, at the end of the year, the landlord reviews the actual expenses against those projected and collected via rent or TICAM from tenants throughout the year. With a pass-through clause, the landlord passes through any overages in those expenses that go beyond what was collected. These “overages” are usually passed to the tenant via a one-time invoice or as additional rent for the following year depending on how the lease is written. Landlords then project their expenses for the following year and the process repeats itself.
Generally speaking, when leases expire tenants are expected to vacate the premises; however, some tenants do not leave. More and more landlords now include a provision in their lease agreements that significantly increases the rent for tenants that “holdover.” These holdover rates can be as high as 250% of the final month’s rent. Ouch! Because some tenants may need to holdover for various reasons (e.g. build-out in new space not completed on time, movers not available, etc.), it’s best to negotiate the holdover rate to be as low as possible prior to signing a lease. Knowing the current trend and what the market will tolerate are keys to success in negotiating holdover rates prior to signing the lease.
As the famous slogan goes, “What’s in your wallet?” To keep more money in your wallet, negotiate rent escalation, pass through expenses and holdover rent during the leasing process. Also, when your lease comes up for renewal, revisit these items to ensure that they are in line with the market and not picking your pocket. Lease renewals are a great time to re-negotiate!
Kim Mills, PHR & SHRM-CP, specializes in Buyer/Tenant Representation at Phoenix Commercial Properties in Raleigh NC. She assists business owners and leaders in securing the best real estate to support their brand, increase employee engagement, drive productivity and overall enhance profitability. Her unique combination of commercial real estate knowledge and human resource expertise enables her to develop and execute workplace strategies that positively impact the people, productivity and profitability of her clients.