Welcome to the WorkSpace Real Estate Podcast, I am your host James Robertson and today we are going to talk about a topic that is very near and deal to my heart. Guaranteed Rent Escalations built into your lease. If you don’t know what I am talking about, here are the industry terms that Landlords will use to “sell” or describe the increase:
• 50 cent bump per year
• Annual Rent Escalation
• Rental Adjustments
• Annual Rent Increase
You will know what I am talking about if you look at your lease and you see the 2% to 10% increase in rent that you will have to pay next year.
Now let me tell you why this provision really irks me as a Tenant broker... If you were to ask the Landlord why the provision is there, here are the excuses.
• This will cover the cost of inflation
• This rent will keep up with the market rent and keep you current
• The banks require us to show an increase
• Or if they are really bold, they will just tell you that this is part of the income goals for the property which is Industry speak for (This is how much profit we want to make so shut up about it)
Here is the main problems with guaranteed rate increase. It will guarantee that you will OVERPAY in rent in nearly all but the strongest markets in Office and Industrial Space. Let me explain using Houston data. In Southwest Houston, if you were to lease office space at $14 per foot in 2012, do a 5 year lease with .50 cent escalations then it would look something like this. Year 1 at $14, Year 2 @ $14.50, Year 3 @ $15, etc.
Now where was the actual rental market at for those 5 years. In Southwest Houston, this market was almost flat, after 5 years the listed rent for the same building stayed about $14 to $15 per foot even at year 5 while if you got these guaranteed increases you would have been $16 bucks a foot! Paying a full $1 more per foot for the same space.
Here is the point, in order to make a great deal you have to reject the assumption that the landlord is entitled to guaranteed increases every year regardless of the market. The only way I recommend that business owners accept these increases is when the market shows through actual rent data taken that they can support those rates. Now I am not talking about asking your neighbor next door or checking online because your neighbor’s rent does not represent the “market rent” in that area and the online rates represent the market as much as the sticker price on a car represents the actual sales price on a new Infinity.
Let me close with a quick stock market story (true story). For all of you savy investors out there, if you invested in the SP500 over the past 20 years you should have averaged an 8-9 percent return annually. If we took you out of the market just 10 of the best days of that 20 year period your earnings would have been cut to less than 4.5 percent. If we took you out of the market just 50 of the best days you would have a negative return on your investment! As a business owner, your not opposed to risk, risk is part of your life. Now the landlord’s building is an investment, and yes they are entitled to a fair deal, but that deal needs to be a win-win for all parties involved.
We cannot expect the Landlord to lease space at a loss anymore than the Landlord should expect to recieve higher than market returns just “because”. The next time you are up for a renewal or relocation, dig into the weeds and understand where the market is headed. Determine what a reasonable rent forecast looks like and talk it over with your broker so that you can develop a winning proposal so that everyone is happy. Remember I said this in another episode that great real estate deals are MADE not found!
If you like what you heard, please subscribe. This is James Robertson signing off, thank you for listening!
