Commercial real estate property owners often need to increase lease rates in order to keep up with the rising costs of maintaining their assets—but the process may not be as straightforward as you think.
In this article, we’ll talk about some creative rent escalation techniques that seasoned commercial real estate professionals use to increase clients’ leases and help them stay profitable in a shifting market.
Profit Sharing and Percentage Rent
A profit-sharing agreement with your tenants enables you to share in the success of their businesses. Very often, a landlord and tenant will agree on a base rent amount and a percentage of the profits the landlord will be entitled to if the tenant’s profits exceed a certain threshold. While it provides landlords with a greater benefit to leasing out their properties, it also encourages tenants to maximize their profits.
A variation of this is percentage rent, which involves a tenant paying a percentage of their sales as rent in addition to a base rent amount. This is another way for you to share in the success of your tenant’s business and maximize returns on your commercial property.
Capital Expenditure Reimbursement and Pass-Through Expenses
These rent escalation methods often go together in a commercial lease contract. Capital expenditure reimbursement lets you as the lessor recover your expenses for capital improvements made to the leased property, while pass-through expenses involve you (the lessor) passing or forward-shifting certain expenses to the tenant, which can include taxes on the property, insurance, and maintenance costs.
Fixed or Annual Rent Increases
Although not the most creative way to escalate rent on your property, fixed rent increases let you impose a fixed annual rent increase as previously agreed upon with the tenant. This approach allows for gradual increases in rent rates over time and is usually the least burdensome for commercial property tenants, which is why it’s one of the most commonly used methods.
This can either come as an agreed percentage increase or one based on a CPI rent review (a set formula for calculating commercial lease rents based on the consumer price index). It can also be a combination of both. In any case, pre-agreed rent increases guarantee that your investment returns keep up with the changing market.
Rent Reopen Clause
A rent reopen clause is a provision in the least contract that basically allows lets the landlord re-negotiate the terms of the lease over a period. A common illustration is when commercial property owners offer low rentals to potential tenants on the condition that in a couple of years, a rent review will be conducted to increase the rent according to changes in market conditions.
Increasing Services
Upgrading the building or amenities may also be a vehicle by which you can raise rents on your commercial property. These kinds of upgrades increase the tenants’ enjoyment of your properties and consequently increase the value of the asset. In some cases, tenants may also ask you directly for specific improvements as needed by their business, and you can do so on the condition of a rent increase by a certain percentage each year.
Conclusion
These are only some of the most creative and effective rent escalation techniques to help your CRE assets remain profitable despite changing market conditions. Whether you plan to offer a profit share agreement, add a fixed rent increase provision in the contract, or use some other method, be sure to consult with seasoned commercial real estate professionals to determine the strategy best suited to your assets.
