A Fresh Take on CRE

Additional Rent!? Post #3 - Operating Expenses

The third major component of "Additional Rent" is "operating expense escalations." This is a charge assesed by the landlord on a yearly basis to account for increases in the cost of operating the building. There are several ways that landlords bill for operating expenses. Without further ado, here it goes:

1) Direct Pass through - Generally considered the most favorable option. With a direct pass through, the landlord bills the tenant for it's proportionate share of the increase in operating expenses. Often the landlord will estimate what what this increase will be and later will adjust the charges accordingly.

2) Fixed Escalation - Often, in lieu of determining a tenant's proportionate share of operatin expense increases, a landlord will simply increase the tenant's rent a certain percentage per year. Currently, the going rate for this set increase is about 3% of the gross rent. While this option offers peace of mind to tenants, it often results in higher payments than a direct pass through. It is important to note, that these increases compound year over year and it is imperative that your real estate advisor performs a comprehensive financial analysis so that you may know exactly what you will be paying in the future. As a quick example, a $65 per sf rent escalataed 3% annually for 5 years will cost you over $73 per sf in year 5! Fixed escalations are most common for small tenants.

3) CPI Escalation - CPI stands for Consumer Price Index. The CPI is a measure of the change in prices of a representative basket of goods and services over time. Baseically, CPI is a measure of inflation. In the case of a lease tied to CPI increases, however much the cost of the basket of goods goes up per year is the percentage that the lease goes up. CPI esclations are still used in NYC, but are relatively uncommon.

4) Porter's Wage Escalation - Unique to NY, the Porter's Wage escalation increases a tenant's yearly rent per sf based on the hourly average increase for Porters in the Local 32BJ union. For instance, if the porters negotiate an increase of $1 per hour a tenants rent will go up $1 per sf. This is called a "penny for penny" increase. There are many variations on this formula, however, including, "3/4 of a penny for penny," "1.5 pennies per penny," and with or without "fringe benefits." Like CPI, this kind of escalation is still used, albeit rarely. Typically, this type escalation is not favorable to tenants.

For other operating expense posts, check out:

Additional Rent!? Post #1 - Electricity

Additional Rent!? Post #2 - Taxes