Title: Why We Insist Upon Annual Increases in Rents
WHY WE INSIST UPON ANNUAL INCREASES IN RENTS
1. MINIMIZES DESTRUCTIVE TENANT “STICKER SHOCK” AT RENEWAL TIME If the Landlord does not increase the rents annually, then the rents the Landlord receives monthly at the end of the lease will be SUBSTANTIALLY BELOW the then Fair Market Value Rental Value of that building
and thus, when you quote a renewal rental somewhat closer to FMV to the Existing Tenant …
the tenant will get “Sticker Shock” and will often move … even if he has to pay even higher rents for equivalent space.
In other words … the Landlord’s simply acquiescing to a request for “fixed rents”, Gravely Risks Committing the Greatest Sin of All … “Running Off” your own Precious Tenant!
Whereas if the “gap” between what the tenant is actually paying monthly at the end of the lease is then “somewhat closer” to the FMV rent quoted for the new lease term … that Risk of Tenant Loss is Significantly Diminished.
The cases where I learned these Bitter Personal Lessons:
Texas Freight Forwarders – 1524
Purse and Company – 1524
Sol Schwartz -Suite 800
2. MINIMIZATION OF EROSION Annual Rent Increases, when properly set out in the lease, keeps the Landlord somewhat “closer” to preserving the Purchasing Power of his Rent in those later years when those rents are collected … and which Purchasing Power is always being CONTINUOUSLY ERODED BY INFLATION under Fixed Rent situations.
3. SHOULD ANNUAL RENT INCREASES BE EFFECTED BY CPI OR BY “STAIR STEPS” Theoretically using the Consumer Price Index, (CPI) to keep the Erosion of Purchasing Power ought to be Ideal … but many things can interfere with that:
3.1. There are several different CPI’s and some of the ones created do not closely relate to economic factors in our locale.
3.2. The US Government has re-defined the CPI several times … which always leads leases already containing CPI Clauses under the old definitions into controversy that if not resolved, leads to time and money wasting lawsuits.
3.3. The CPI figures are published at intervals that sometimes change at unpredictable times and thus don’t change at the right time to adjust the rents timely contemplated when the lease was written years before. Once President Carter caused the CPI Publication Date to be “moved” and moving that date meant that the CPI in existence on the lease “rent increase date” was the old one CPI instead of the newer one intended and that cost me a lot of lost money.
3.4. Sometimes the change in the CPI does not relate to the business we are in … for example, when durable goods manufacturing is doing well and residential real estate is doing well but commercial real estate is not doing well.
3.5. Lots of lawyers do not know how to properly craft a CPI clause.
3.6. CPI clauses always create time wasting controversy when it is time to raise the rent. This controversy not only wastes the landlords and tenants time … but it often results in lingering bad feelings that are destructive to renewal effort at renewal time.
3.7. Stair Step Rent increases are very easy to define and if they are clearly written in the lease, no one argues with them when the rent goes up. The “key” is whether the landlord is clever enough to make his stair step increases stay even with his intended plan.
4. LENGTH OF LEASE TERMS There is nothing “magical” about using round numbers of whole years in lease terms.
For years, I thought about standard “3 year” and “5 year” and “10 year” leases. Recently I have discovered that this is ONLY IN MY MIND … often tenants have no objection whatever to a lease of “7 years and 4 months” … or “60 months, less 2 days”
4.1 Great Reasons for NOT using “Round Number of Whole Years” leases
4.1.1 Lease Marketing should be a constant and consistent effort and where possible, should be structured so that it takes into account, realistic factors happening in the market place.
4.1.2 Examples: In retail leasing, there is NO marketing activity IN THE RETAIL MARKET in this locale from October 1st until the first week in January because the potential retail tenants are focused on tending to their Christmas business and upon nothing else …
So why should a smart landlord ever permit a lease term to end during that period? … when your broker can’t even get new potential tenants attention during that time of year and the space thus, sits vacant until after the first of the year.
In my operation, I make all RETAIL lease terms end on February 28th so that right after the first of the year, my broker can “warm up” and begin marketing it. This gives my marketing people the Optimum and Maximum Time to market my space … 9 full months (until October 1st) to lease it up.
And the tenant still knows he has about 9 weeks after Christmas to either move out or renew.
And this works well as long as that individual property has few enough tenants so that not too many spaces come vacant at the same time.
4.1.3 When a large non-retail commercial property lease term is going to end with a term that the parties want to end at about year end, in my operation I always make the lease term end 2 days before Year End so it will be “vacant” on December 31st … the day upon which the Bexar Appraisal District is required by State Law to value it for Property Tax Purposes.
It is far better for my Property Taxes to have it “vacant” ON THAT DAY, than to have it be considered “leased” for tax purposes under the law on that day … and then go “vacant” the next day because I stupidly permitted a 31 day month to be used as the last month of the lease term.
4.1.4 It is far better for landlord to plan out the lease expirations at lease negotiation time by using non “round number” leases so that you do not have too much space on the market at one time … this not only hurts the landlords cash flow …
but in addition to the loss of cash flow, it can be a “Double Whammy” when 2 or more spaces of similar product come on the market at the same time … for then you also compete with yourself!