By Indhira Desangles
Special for El Inmobiliario
When your business grows and it's time to expand operations to a new office, retail space, or warehouse, it's easy to focus on finding the perfect location and overlook the contractual details that can have a long-term impact. One such crucial detail is the annual rent increase clause in commercial lease agreements.
What can happen if you don't pay attention to this clause?
In many cases, businesses face unexpected rent increases that severely impact their cash flow, making financial planning difficult. Today I'll explain what an annual rent increase clause is, why it's so important, and the best ways to negotiate effectively.
What is an annual rent increase clause?
An annual rent increase clause is a section in commercial lease agreements that stipulates how the rent will be adjusted year after year. This is done to reflect changes in the economy, such as inflation, and ensure that the property's value does not depreciate due to market fluctuations.
It is important to note that this clause is not standard and can be negotiated depending on the needs of both parties, landlord and tenant.
Options for Negotiating Annual Rent Increases: Which is Best for Your Company?
There are different methods for establishing annual rent increases in a lease agreement. Depending on the strategy you choose, you could have greater control over your budget and avoid unpleasant surprises. Here are the main alternatives:
1. Fixed percentage increase:
This is perhaps the simplest method to understand and negotiate. Both parties agree on a fixed percentage annual increase in rent, which could range from 2% to 5%, and in some cases up to 10%, depending on the economic context and the relationship between the parties.
Advantages:
Predictability. You know exactly how much your income will increase each year and can plan your budget long-term.
Easy to negotiate. Both parties agree on a figure, eliminating uncertainty.
Disadvantages:
It doesn't always reflect real economic fluctuations. If inflation is higher than the agreed-upon percentage, the landlord might feel their property is losing value.
2. Increase based on the CPI (Consumer Price Index):
A more flexible option, better aligned with economic realities, is to base increases on the United States Consumer Price Index (CPI), specifically the CPI-U (Consumer Price Index for All Urban Consumers). This index measures changes in the prices of goods and services and reflects inflation.
Advantages:
Fair adjustment. Reflects the true cost of living, making it more balanced for both parties.
Protects against disproportionate increases.
Disadvantages:
Unpredictability. Increases depend on external factors, so you could face adjustments that are larger or smaller than expected.
Difficulty in negotiation. Some tenants may feel uncomfortable relying on an index they don't control.
You can check the CPI on the U.S. Department of Labor's website here: www.bls.gov/cpi/
3. CPI + Percentage Combination
: A hybrid option is to combine a CPI-based increase with a fixed percentage, for example, CPI + 2%. This allows you to adjust the rent according to inflation, but adds a margin that ensures the landlord maintains the value of their property.
Advantages:
Protection against low inflation. If the CPI is low, the fixed percentage ensures the landlord receives a reasonable minimum increase.
Flexibility. It combines the best of both options.
Disadvantages:
Potentially higher increases. By adding a fixed percentage to the CPI, you could face larger increases if inflation is high.
4. CPI with a "floor and ceiling"
Another very useful option is to agree on a raise based on the CPI, but with a floor and a ceiling. This means that the raise will never fall below a minimum or exceed a maximum, regardless of what happens with inflation. For example, you could agree on a minimum raise of 2% and a maximum of 5%.
Advantages:
Control and security. It protects you against excessive increases, but also ensures the landlord receives a reasonable adjustment each year.
Negotiated flexibility. Both parties are clear about the limits of the adjustments.
Disadvantages:
Complexity in the negotiation. It can be difficult to agree on the appropriate range between landlord and tenant.
What about the security deposit? It matters too.
Not only does the monthly rent need to be adjusted, but the security deposit also needs to be recalculated if there's an increase in the rental price. Generally, the deposit is equivalent to two months' rent, so if the rent goes up, the deposit should also be adjusted to reflect the new value.
Conclusion: Negotiate wisely to avoid surprises.
In short, negotiating the annual rent increase clause in your corporate lease is crucial to protecting your company's financial stability. Whether you opt for a fixed percentage, an adjustment based on the Consumer Price Index (CPI), or a combination of both, it's important that both parties are clear on the terms.
In a changing economic environment, having a well-negotiated increase clause can make the difference between a stable contract and one that ends up affecting your operations.
The author is: A specialist in commercial and corporate real estate, with more than 20 years in the national market.
