What is the math behind annual rent increase
I am looking to buy a business where the property owner is asking for an annual increase of 3% on a triple net lease. I know the building is paid off so each dollar goes in his pocket. I’m trying to negotiate this number down by indexing it to a local CPI number. The response I got was indexing to CPI in commercial real estate went out many years back. I think he’s full of $hit so I asked why, and he said he doesn’t have a clue. Ultimately, what’s the purpose of 3% escalator when I’ve got to cover all expenses pertaining to my property. It’s not like his expenses to maintain are going up cause I have to pay for everything. Thought the folks in this community can help me with the math/rationale.
[{"id": "eqz25im", "text": "TL/DR: If you don't want to pay market rent escalations, another tenant will.\n\nExplained:\nAt the end of the day, the Landlord will always have different motivations than you.  Expecting that his rent growth will only track basic inflation ignores the fact that this property is part of a specific marketplace, and one that is (in today's market) likely subject to scarce competition.  It is truly a Landlord's market in most places across the country right now.  The Landlord also faces a big opportunity cost to not maximizing the rents they can achieve on a space (read: risk).\n\nFor example, I'm in Texas, and the market here dictates that 2.5%-3% annual rent increases are the market standard.  If one particular Landlord was especially motivated to achieve occupancy over maximizing their effective rents, they may reduce or eliminate the annual escalations, but with as tight as the local market is (&lt;10% vacancy across property types), they don't really need to do so to get deals done.\n\nMost other Landlords here are charging similar escalations, and 100% of the sophisticated/institutional Landlords are, so it's effectively what the market dictates is \"market-standard.\"\n\nAs for why it is this way, it's really a product of wanting to hedge against inflation plus tight vacancy that allows a Landlord to command 3% when inflation is &lt;2%.", "replies": [{"id": "eqz3k46", "text": "Thanks, that makes sense. I don\u2019t want to pay more to move the business and I\u2019m sure he doesn\u2019t want to go chase a new tenant so I\u2019m hoping we can land somewhere in the middle.", "replies": [{"id": "eqzi1m2", "text": "What\u2019s the term of the lease? 5 years? Hopefully you are growing the business far in excess of the 3% rental growth. The motivation for the landlord is he/she only makes the 3%, while your operating business can grow 50% yr/yr.\n\nWhat would it cost to move the business? What are comparable properties renting for in your market?", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "eqz2cun", "text": "2-3% annual rent increase is very common in NNN leases . Don\u2019t know exact rationale but it\u2019s basically industry standard", "replies": [], "depth": 1}, {"id": "eqz2xnq", "text": "I\u2019m buying retail/pharmacy. I\u2019m fine with property owner increasing rent pegged to cpi but a 3% increase perpetually seems excessive.  We haven\u2019t had CPI greater than 3% in the last 8 years which means I have to keep paying more in rent but I can\u2019t pass that through to my customers without pricing myself out.", "replies": [{"id": "eqznehm", "text": "I don\u2019t know your market, but market rents may have increased by 3+% per year.", "replies": [], "depth": 2}], "depth": 1}, {"id": "eqz5ox8", "text": "Every deal is different, and the market is continually adjusting to what one party will give and the other will take, so go get it done!\n\nThere are certainly leases that have below-market terms, I only wanted to help explain why these are pretty normal within today's market.  Good luck!", "replies": [], "depth": 1}, {"id": "eqz6gtd", "text": "Cpi still exists.", "replies": [], "depth": 1}, {"id": "eqzsdn4", "text": "3% is pretty normal. I rarely see any landlord use a CPI or COLA increase anymore. Only leases I review with those types of increase are dated at least a decade ago. Good point though... I don\u2019t know why it\u2019s not used anymore... it\u2019s just not... \n\nI work the Orange County CA office market, it\u2019s not uncommon to get annual increases as high as 4.5% from certain landlords. And tenants pay it.", "replies": [{"id": "er0auxe", "text": "Can confirm I rent in OC, land lord does a 4.5% increase yearly :( almost that time of year again", "replies": [], "depth": 2}], "depth": 1}, {"id": "er0k7ew", "text": "What amount, if any, of tenant improvement allowance are you getting? I would advise that you try to get some or more TI on the basis that the funds are ultimately improving the owners space. Upfront TI as a cost to the owner is a fraction of the capitalized value benefit they\u2019re receiving from a rental rate escalating at 3%.", "replies": [], "depth": 1}, {"id": "er0rc7k", "text": "To stay competitive the landlord needs to follow trends. If they want to sell in a few years, they need a standard lease with market increases in place.", "replies": [], "depth": 1}, {"id": "er2dx0f", "text": "In retail, 3% is pretty standard with little wiggle room. You can also do a 10% bump after 5 years if you sign a 10 year lease. If the LL is not putting dollars in the form of TIs, then you can negotiate lower rent likely. In office you can definitely get away with lower escalations.\n\nSource: in asset management in retail with about a 100 property portfolio", "replies": [], "depth": 1}, {"id": "erdfplu", "text": "annual increases are simply party of the negotiation process, just like base rent, abatement, tenant improvements, etc. He is right that few deals use CPI growers anymore. The actual increase depends of course on the market, but 3% is probably close. Your wording suggests you feel you are getting ripped off. It's purely business - he is trying to earn as much as he can from his asset - just like you are trying to earn as much as you can from the business you are buying. Make sure you use an attorney when you get to the Lease itself, and depending on where you are, get familiar with the property tax rules - some places (CA) you could have major exposure if the property sells.", "replies": [], "depth": 1}]