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All office leases contain various formulas to increase (escalate) your rent during the term of the lease. These provisions were first developed to protect the landlord's bottom line against increases in operating costs. More recently, especially during tight market conditions, they generate a hidden profit center for the landlord, often at a substantial, and unjustified, cost to the tenant.
Every transaction you consider will trigger a different escalation pattern. The rent in Buildings A and B, both $25 per square foot at the outset, might rise to $35 after 10 years in Building A, but mushroom to $60 in Building B. This is a critical area for both financial projection and aggressive negotiation, where you will depend on your broker to contain your future occupancy costs.
Landlords have become extremely creative in devising escalation clauses that protect and generate their profit at tenants' expense. Among the most common are the following:
Tax Pass-Through
If the property taxes go up, you are charged a proportionate share of the increase. The lease specifies the percentage of the property that you occupy, which must be verified.
Direct Operating Cost Pass-Through
If operating costs (heat, power, maintenance, security, etc.) go up, you are charged proportionately in the same way. The lease should specifically exclude capital improvements, management fees and many other costs from this calculation.
Porter Wage Formula
Each penny-per-hour increase in the porter wage generates a penny per-square-foot increase in rent. This formula generates substantial profit for the landlord. If fringe benefits are included, the profit is even greater. Avoid if possible.
Indexed Escalation
Your rent goes up each year, by a fixed percentage or by the percentage increase in the Consumer Price Index. Big profits for the landlord. Avoid if possible.
Every escalation clause specifies a "base year", after which escalations apply. Negotiation of the base year can be as important as negotiation of the formula.
And the negotiation of the escalation formula can even more important than the negotiation of the base rent. This is another area where you need exert advice and genuine commitment from your broker.
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