Rental increases: how much is too much?

It is a rule of basic economics that along with petrol, food prices and everything else, rentals need to increase annually. “In the past it was an accepted norm that the landlord would expect his eight to ten percent annual increase, irrespective of economic circumstances,” says Leon Breytenbach, National Manager of the Rawson Property Group’s commercial division, “but today it is more frequently accepted that rent increases will be negotiated by the landlord and tenant to set a figure agreeable to both parties.”

From the landlord’s viewpoint

The landlord must cover his costs pertaining to the property. He cannot be expected to maintain the original rental indefinitely, as inflation, the prime lending rate, insurance, property maintenance and municipal rates, to name just a few, are never static. He would therefore argue in favour of a higher escalation so as to cover the ongoing obligations of owning a commercial property. It is, however, necessary to ensure that the property rental remains at a market related level in order to make it attractive to prospective tenants or to retain a good one who has leased it for years, while still achieving a viable degree of profit.

The tenant’s side of the matter

“The tenant, on the other hand, wants to maintain the status quo and would argue in favour of a lower escalation,” says Breytenbach. “He would question the value derived from the monthly rental spend and the increase applicable thereto, generally without any visible added value.” If pushed beyond what he regards as a reasonable increase, he may advise the landlord of his intention to move out at the termination of the lease. A longer term of lease is far better than a short one, as discussed in a previous article, “What’s better: To buy or lease your commercial property?”

Renewal of a lease

“As mentioned, the landlord is not always entitled to the presumed increase norm of eight to ten percent,” says Breytenbach. “Generally there is a clause in the contract that the existing rentals, together with the previous rental escalation agreed to, will continue to apply on a month to month basis while the parties negotiate the terms of the renewed lease.”

Points to consider before renewal

The property owner should consider whether the tenant proved himself to be a worthwhile lessee. Was the rental paid timeously? Were unreasonable requests made during the lease term? Were the use, upkeep and maintenance of the property acceptable? Did the tenant get along with the neighbours?

He must also decide if it is worth the hassle of seeking a replacement tenant. How difficult would it be to source a new, hopefully good, tenant? What are the current market rentals? Is it worth it to rock the boat and risk having your good tenant leave?

The tenant must then consider his past relationship with the landlord. If it was good, could the ‘grass be greener’ with a different landlord? What value will he get for the rent paid and is the value comparable to similar properties in the area? What will it cost to move to new premises and what other implications, such as inconvenience, locality, accessibility, will arise out of such a move? The tenant could possibly get the landlord to agree to carry out some improvements to the property in return for renewal and renegotiation of the lease.

When deciding on rental increases, both parties should maintain reasonable expectations, respect the other party’s view and be prepared to compromise, if needed, in order to sign up for another three or more years. “There is no need to go legal on the matter,” says Breytenbach, “the opinion of a qualified and active commercial broker could go a long way to building a bridge between the parties. “Better yet, as a landlord, you could leave the negotiations up to a local commercial property broker, if they manage the property for you.” Either way, let a commercial broker give you some comparables and reasons why the new rental and escalation has been recommended, always taking into account the other party’s valid opinions which may contradict your’s in the matter.