Beware of the Commercial Lease’s ‘Escalation Clause

March 17, 2016

contractUnless your company is getting a short-term lease, your commercial lease is most likely going to include what is known as an escalation clause. This clause automatically increases the amount of your base rent over the years, with the premise of paying for increases in the costs related to the building. While such clauses are common and totally valid, they can also be a keen way for a tenant to fall into a massive money trap.

Escalation Clause Structure

Landlords and tenants have several options when it comes to structuring the escalation clause.

The base rent can be increased by:

  • A fixed amount each year
  • A percentage each year, based on the consumer price index or other inflationary index
  • The actual increase in the landlord’s real estate taxes and expenses, with expenses related to maintaining, operating and insuring the building
  • A combination of two or more of the above methods

Reading the Fine Print

Tenants can get into trouble when they fail to carefully negotiate the definition of items that fall under a landlord’s operating expenses. The common area maintenance (CAM) clause, which covers operating expenses for maintaining common areas, has been one area historically riddled with abusive overcharges.

Eight of the most common overcharges include:

  • Capital costs erroneously categorized as repairs
  • Parking garage expenses supposedly not fully reimbursed by the parking income
  • Entertainment, travel and other costs the lease is not supposed to cover categories as “miscellaneous expenses”
  • Rebates, refunds and tax abatements not credited to tenants
  • Expense reductions not credited to tenants
  • Double billed utility services the tenant paid individually and was charged for again under general utility costs
  • Accountant fees for landlord’s tax return preparation
  • Build-out expenses for an individual tenant categorized for all tenants to fund

Lease auditing is typically the only way to uncover this type of CAM abuse, as tenants generally don’t receive detailed breakdowns on the expenses for which they’re paying.

Working with a commercial real estate agent helps you avoid unscrupulous landlords and their practices. You’d also be wise to negotiate a cap on how much your base rent can ultimately be increased to best protect you over the years.