Negotiating industrial leases for warehouses and factories in the Randburg northern areas.
What is meant by rental escalation?
It is merely a mechanism to align the growth in current rentals to anticipated future market rentals.
What a landlord wants to avoid is a situation whereby lease term rentals are growing at a rate below actual market values.
Why do Landlords insists on escalations of 9%p.a and above when CPI is around 6%?
First of all lets understand how CPI is arrived at:
Consumer Price Index (or CPI) is an index generated by StatsSA that measures “the prices paid by urban consumers for a representative basket of goods and services.”
It is argued that the basket of goods used to measure CPI is not representative of the property market in general and is therefore not a fair reflection of increases for such components as wages, construction materials, consumables and rates and taxes (if applicable) etc. In other words 6% in 2016 may not be acceptable.
The other thing to consider is the make up of a gross rental:
Intuitively one would think that a gross-rental escalation rate (for a given period of lease) is a function of two factors:
- Expected (operating cost) inflation rate
- Expected net rental growth rate
If we remember that Gross rental (100%)
= Net rental (say 85%) + operating costs (say 15%), one could say that:
Net rental escalation = function of expected rental growth
Operating costs escalation = function of expected inflation rate
Now, if we accept the above weights, we can see that the main determinant of escalation rates is expected rental growth.
The final point is that property investors purchase property at a hurdle rate (IRR) which is more than double the CPI (currently) and accordingly require net operating incomes which grows at a rate commensurate with their investment. Another simple way to look at it is to say that they would like to have a rental growth rate that exceeds the bank savings rate other wise there would not be much incentive to continue investing in property.
Having said this, landlords understand the value of having a “blue chip” tenant on a long lease and can factor in lower escalation rates matching CPI. This however is achieved on high yielding properties and not on low yielding properties which have been acquired at substantially higher costs. For example a new development in an upmarket node.
In conclusion, successfully negotiating lower escalation rates will depend a lot upon the strength of the lease agreement as well as an understanding of the targeted property and its position/status in the local property market. Of course it helps to be able to discuss these factors amongst others with a knowledgeable broker.
Well thats my view. If you would like to renegotiate your current lease thats coming up for renewal you are welcome to give the author a call on 082 558 0292 to discuss your options.