Panama City Commercial Real Estate Articles
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Introduction to Commercial Leases | Part 2
Lease Clauses that affect Cash Flows (Continued)
Fixed Rental is where contract rents are fixed for the duration of the lease.
With Step Leases, contract rents on long-term leases change by preset amounts or percentages on predetermined dates, such as each year or every five years. Although the lease payments vary over the term of the lease, all payments are determined and known at the beginning of the lease agreement. Therefore, unless the tenant defaults, all lease payments are known with certainty when the lease is signed.
The base contract rate may increase by a present amount or percentage. Such preset amounts or percentages are called escalations. Types of costs typically having escalations may relate to real estate taxes, insurance, utilities, operations, and maintenance.
Real estate professionals representing the tenant provide information about historical trends so that increases are predictable and informed decisions are made.
Indexed leases is where contract rent is tied to movements in a prespecified index, usually the consumer price index (CPI). As an example, if the current year’s cost of living increases by 3 percent, then the next years lease payment will increase by 3 percent. Indexation prevents inflation from eroding the real value of the tenant’s lease payments and passes inflation risk from the owner to the tenant.
Percentage rent, also called overage rent, is additional rent over a base amount that is paid by retail tenants to owners on tenant sales over a certain dollar amount, called breakpoint.
This clause is frequently found in shopping center leases in which an owner manages and promotes the entire center. The base rent is lower because the owner expects additional rent from sales. Percentage rent is usually calculated and paid on an annual basis.
Tenants like percentage rent because it gives the owner/landlord a stake in their success, encouraging the owner to make a solid decision on tenant mix, the attractiveness of the retail property, signage, and maintenance that will have a beneficial effect on tenant sales. Additionally retail tenants like percentage rent because of the cyclical nature of their sales – retailers make most of their income during holidays or seasonal peaks.
Sometimes owners will offer tenants rental concessions, such as several months of free or reduced rent or free parking. Rental concessions more frequently are observed in over built markets because the owners find the leasing of space more difficult or because of unique circumstances in the tenants short term cash flow. Another explanation is that free rent may be negotiated to help the tenants pay for tenant improvements. Such concessions lower the tenant’s effective rent, unless the base rate is stepped up to adjust for the initial reduced cash flow to the owner.
© Copyright 2008 Jennifer MacKay. All Rights Reserved.
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