Inflation Escalation

Inflation and rising costs are at the forefront of everyone’s mind as we enter 2023. The current volatile market makes it more important than ever to understand the rent escalation clauses in current and future commercial lease agreements.

Suited figure in front of rising market and inflated balloon

Ashley S. Wagner

February 20, 2023 12:00 AM

A Bit of Background

Some commercial leases provide for fixed, consistent annual increases in rent, whereas others provide for rent to increase at intervals relative to certain economic metrics like the consumer price index (“CPI”). This distinction is particularly important when considering commercial tenant renewal options. When inflation is high or experiencing rising levels, as we saw throughout 2022 and as we move into 2023, rent increases that are dependent upon economic metrics to calculate the increased amount of rent may result in unexpectedly (and often unwelcome) high rent amounts for a commercial tenant and may result in an unexpected (but welcomed) windfall for the commercial landlord. To those who follow the commercial real estate market, some of the consequences of unanticipated formulaic rent increases are already apparent, however focusing on these issues now may help to curtail landlord-tenant disputes and, hopefully, minimize non-payment of rent for commercial landlords and business risk for commercial tenants.

Negotiating a Lease with an Eye Toward Rent Increases

Every commercial landlord should be negotiating its commercial leases while keeping in mind two primary concerns:

  1. safeguarding its property interests and
  2. sustaining its profitability

For commercial tenants, managing and minimizing risk and protecting against unforeseen expenses are crucial when negotiating a commercial lease agreement.

It is important that landlords and tenants alike are clear on the rent terms, and particularly the rental increases, in their commercial leases. Commercial leases often provide for annual rent increases at a fixed rate (often 2-3%). Sometimes, these increases are not annual but rather bi-annual or every few years, or occasionally there are no increases in the initial term of a lease, with increases during any renewal term. Some commercial leases provide for increases that are not fixed but rather are tied to CPI or other economic metrics, and still others use a combination of methods to provide for escalation of various rental amounts.

For better or for worse, depending on which party you are in the commercial lease, inflation and rent escalation clauses that rely on economic metrics are directly related—as inflation rises, rent rises in direct correlation with it. While inflation has ebbed and flowed throughout history, recent and fast-rising inflation is creating unanticipated results for all involved.

Top Three Rent Escalation Structures

  1. Fixed Increases – these allow landlords to increase base rent by a set amount or set percentage on a previously agreed-upon timeline throughout the duration of the term. This is the most common type of increase for base rent, and it is arguably the most straightforward method. However, fixed increases do not account for changing market conditions, which is a complaint often heard from commercial landlords. In times of high inflation, a landlord may end up losing its desired profit margin if costs have gone up and the fixed increases no longer cover those rising costs. Fixed increases are sometimes referred to as stepped or percentage increases.
  2. Indexed or Variable Escalation – this option allows landlords to increase base rent in proportion to increases in established economic indexes, such as CPI. Although indexed escalation increases can be used annually during the initial term of a lease, it is common to use this method to establish rent for a renewal term, aligning rent for the renewal term with the economic environment. Although landlords may lean toward this option during times of high inflation, it is less favored by tenants because index increases can be unpredictable and dramatic. Consider that in January 2021, CPI for all consumers was up 1.4% from the prior 12 months, whereas by January 2022, it was up 7.5%. In addition, while index increases may align with national economic trends, they may not represent local real estate trends—which may be trending higher (Bozeman, Montana, anyone?) or lower, depending on the area.
  3. Pass-Through Escalation – this type of increase is a form of rent escalation that is initiated only when the landlord experiences an increase in specified costs as dictated by the lease agreement. This is most common in leases where a commercial tenant is responsible for reimbursing a landlord for building operating expenses and/or common area maintenance.

Often a commercial lease will provide for fixed or indexed escalation increases in base rent as well as pass-through escalation for additional rent amounts.

Implementing Rent Escalators and The Takeaway

When it comes to rent escalators tied to indexes, it is critical to understand how the current economic environment will impact future rent. A common issue is whether an existing commercial tenant should exercise a renewal option it may have in its lease. Often, tenant renewal options provide for rent to be calculated using market metrics. Ostensibly, this works in the tenant’s favor when the economic environment is stable and inflation is low. In such cases, the formulaic rent escalations adjust the rent to where the market suggests it should be and typically yield a result both parties will accept. However, in volatile market conditions with high inflation, the formulaic rent escalations could adjust the rent to extreme amounts not expected by either party. For tenants, this could create an increase in rental amounts beyond what may have been budgeted or what is sustainable by the tenant’s business. For landlords, this could create scenarios where tenants are unable to afford the drastically increased rent, leading to a higher rate of default or non-renewal and, potentially, unwanted vacant space.

For commercial tenants, managing and minimizing risk and protecting against unforeseen expenses are crucial when negotiating a commercial lease agreement."

Commercial landlords and tenants often have similar goals in that tenants desire to pay a fair market rent and landlords wish to ensure steady rent payments (reasonable rent=regular payments). If, for example, a commercial tenant is coming up for renewal in a lease relying on CPI, the first step would be to communicate concerns to the landlord. Most landlords would often welcome reasonable dialogue, prior to any default or notice of non-renewal, to discuss present economic conditions. Since a commercial lease has many components, there are many intangibles that can be negotiated for a renewal term to soften the blow of drastically escalating indexed rent. These could include improvements to the space, storage or expansion space, longer term and others.

If a commercial lease is at its initial negotiation stage, then instead of inserting standard provisions that use straightforward economic metrics to determine future rent (which many tenants would hesitate to agree to in this climate), landlords and tenants can provide for limits, or caps, on market index related increases. Another option is to identify and use localized real estate market metrics as the basis for increasing future rent instead of using national indexes so that any resulting increase is better aligned with the regional market instead of national economic trends.

Whatever the solution, we all must buckle in to get through this era of inflation with our commercial leases still intact.

Ashley S. Wagner is an attorney and shareholder at Tucker Arsenberg and regularly drafts and negotiates a broad range of complex contracts and agreements for her clients and handles commercial lease and real estate purchase transactions. She also represents clients in stock and asset purchases, and assists with corporate governance, entity formation and general legal advice. Additionally, Ashley has experience guiding entities through obtaining certification as a women-owned business.

Headline Image: Adobe Stock/Travel Drawn

Related Articles

Infrastructure Restructure

by David A. Lum

Developers are embracing creativity and ESG to continue their real estate projects amidst a backdrop of inflation, supply chain demands and pipeline issues.

Two figures standing in construction site

Foreclosure Exposure

by Lindsay Mesh Lotito and Zachary J. Manasia

New York recently passed new legislation surrounding foreclosure law, but questions linger about how much it will help—or hurt—those it affects.

Wallet, safe and house in front of blue background

Electric Vehicles and Zoning Laws

by Aaron S. Evenchik and Robert A. Cooper

As electric vehicles become more common among drivers, so too will charging stations, both in abundance and location. Where these stations are placed, though, could present several challenges and potential impacts on zoning laws.

Fuel pump and electric car charger with red and blue backdrop

Rising Transfer Taxes

by Angus C. Beverly

Transfer taxes in California are becoming a statewide trend with potentially national implications. Here is a breakdown of the effects in several cities.

State of California in orange with city in backdrop

The Commercial Conundrum

by Brion J. Kirsch

Even prior to 2020, commercial real estate was experiencing setbacks. Coupled with the challenges of new working environments and less need for commercial spaces, landlords are left with increasingly vacant buildings to fill. Below is a primer on how to move forward.

Pile of old chairs and office equipment with blue backdrop

Big Updates in the Big Apple

by Nina M. Roket and Thomas D. Kearns

A Post-COVID-19 update on the commercial market for landlords, building investors and retail developers in New York.

Abstract skyscrapers and buildings in multi-color

A Look Ahead

by Jarred Boyer

The future of U.S. rental markets may seem uncertain as we continue to grapple with the after-effects of COVID-19, but renters and landlords alike can look toward a more hopeful few years as inflation already begins to recede and the promise of stabilization is on the horizon.

Paper houses and crane sitting amongst coins and money

Does the Crystal Ball Predict a Fall?

by Kathleen Bernardo

In the post-pandemic climate, economists are making many predictions about what’s to come for the housing market. But one real estate lawyer with decades of experience says that this reset was crucial and not necessarily indicative of the doom and gloom we thought we were facing.

Multi-colored houses with purple backdrop

Withstand the Ban

by Jeffrey A. Calabrese and Kirby Black

With the recent Federal Trade Commission’s announcement proposing a complete ban on noncompete agreements, we offer advice to companies moving forward.

Figure out of frame signing a non-descript contract

Employers Are Budding Heads on Marijuana in the Workplace

by M. Tae Phillips and Melanie C. Cormier

As employment lawyers, we receive many questions from employers navigating marijuana legalization. Below, we answer the top three most asked questions.

Statue of Liberty holding a marijuana joint

Noncompete Extinct

by Mark W. Bakker

The Federal Trade Commission has proposed a blanket ban on noncompete agreements that could radicalize post-termination protections afforded to employers.

Dark figure walking up red staircase to open door

Rights and Wrongs

by Shannon Pierce

Antidiscrimination enforcement agencies, both federal and state, are likely going to be highly active in the next five years. Are Nevada businesses ready?

Faces of women overlapping in multi-color

Brace for Impact

by Ray Young, Jr. and Scott Hetrick

The 2021 independent contractor rule might have major impacts on employers and upend compliance issues, especially as the DOL’s definition of an independent contractor is about to change.

Silhouetted figure holding the hands of a clock

The Top 7 Things to Know Before Filing for Divorce

by Best Lawyers

Consulting with a qualified divorce attorney can help you understand your rights and obligations when filing for divorce. Here are 7 things you should know.

Two golden wedding bands with a crack down the middle

5 Mistakes to Avoid In a Slip and Fall Lawsuit

by Best Lawyers

Learn how to avoid common mistakes during a slip and fall lawsuit. Report the accident, seek medical attention, gather evidence and speak to an attorney.

Yellow caution sign with blue wet floor background


Leadership and Commitment

by Justin Smulison

Malone Law leader and 2016 Medical Malpractice Law – Plaintiffs “Lawyer of the Year” Adam Malone discusses how his success transcends the courtroom and helps strengthen public and legal communities.

Suited man standing with arm resting on table

Trending Articles

Whistleblower Legislation Opens the Doors for More International Claims

by Justin Smulison

An Anti-Money Laundering Act, part of a recently passed Omnibus Budget in the U.S. Senate, is expanding protection for whistleblowers both domestically and internationally.

Shadow figure in spotlight against red and blue brick wall

The Best Lawyers in South Africa™ 2023

by Best Lawyers

Best Lawyers proudly announces lawyers recognized in South Africa for 2023.

South African flag

Announcing the 2023 The Best Lawyers in America Honorees

by Best Lawyers

Only the top 5.3% of all practicing lawyers in the U.S. were selected by their peers for inclusion in the 29th edition of The Best Lawyers in America®.

Gold strings and dots connecting to form US map

Best Lawyers Voting Is Now Open

by Best Lawyers

Voting has begun in several countries across the globe, including the United States, the United Kingdom and Europe. Below we offer dates, details and answers to voting-related questions to assist with the voting process.

Hands holding smartphone with five stars above phone

Best Lawyers: Ones to Watch in America for 2023

by Best Lawyers

The third edition of Best Lawyers: Ones to Watch in America™ highlights the legal talent of lawyers who have been in practice less than 10 years.

Three arrows made of lines and dots on blue background

Rising Transfer Taxes

by Angus C. Beverly

Transfer taxes in California are becoming a statewide trend with potentially national implications. Here is a breakdown of the effects in several cities.

State of California in orange with city in backdrop

Could Reign Supreme End with the Queen?

by Sara Collin

Canada is revisiting the notion of abolishing the monarchy after Queen Elizabeth II’s passing, but many Canadians and lawmakers are questioning if Canada could, should and would follow through.

Teacup on saucer over image of Queen's eye

Famous Songs Unprotected by Copyright Could Mean Royalties for Some

by Michael B. Fein

A guide to navigating copyright claims on famous songs.

Can I Sing "Happy Birthday" in Public?

What the Courts Say About Recording in the Classroom

by Christina Henagen Peer and Peter Zawadski

Students and parents are increasingly asking to use audio devices to record what's being said in the classroom. But is it legal? A recent ruling offer gives the answer to a question confusing parents and administrators alike.

Is It Legal for Students to Record Teachers?

Announcing the 2023 The Best Lawyers in Canada Honorees

by Best Lawyers

The Best Lawyers in Canada™ is entering its 17th edition for 2023. We highlight the elite lawyers awarded this year.

Red map of Canada with white lines and dots

Announcing The Best Lawyers in Australia™ 2023

by Best Lawyers

The results include an elite field of top lawyers and firms from Australia.

The Best Lawyers in Australia™ 2023

The Upcycle Conundrum

by Karen Kreider Gaunt

Laudable or litigious? What you need to know about potential copyright and trademark infringement when repurposing products.

Repurposed Products and Copyright Infringemen

Caffeine Overload and DUI Tests

by Daniel Taylor

While it might come as a surprise, the over-consumption of caffeine could trigger a false positive on a breathalyzer test.

Can Caffeine Cause You to Fail DUI Test?

Wage and Overtime Laws for Truck Drivers

by Greg Mansell

For truck drivers nationwide, underpayment and overtime violations are just the beginning of a long list of problems. Below we explore the wages you are entitled to but may not be receiving.

Truck Driver Wage and Overtime Laws in the US


2022: Another Banner Year

by John Fields

Block O’Toole & Murphy continues to secure some of New York’s highest results for personal injury matters.

Three men in business suits standing in office

Choosing a Title Company: What a Seller Should Expect

by Roy D. Oppenheim

When it comes to choosing a title company, how much power exactly does a seller have?

Choosing the Title Company As Seller