How Does Real Estate Escalation Work?

One of the items that comes up at both the term sheet stage and the lease negotiation stage is real estate taxes. Who’s going to pay them and how does real estate tax escalation work?

The typical procedure in most office leases and most commercial leases in New York is for the tenant to be responsible for a real estate tax escalation and being responsible for that. And they share that is proportionate to the amount of the building that they’re using.

So for example, if my office is 10% of a particular building and the year that I take occupancy of the building, taxes are $1 million. The landlord is paying that million dollars all across the board for the building. The following year and what we call that the base year. So in the first year when you take occupancy, you’re not paying any taxes.

But after the base year, to the extent that taxes go up and let’s say they go up from $1 million to 1 million, $100,000, I as a tenant of 10% of the building, I’m going to pay 10% of that escalation.

So that $100,000, $10,000 is now going to be my responsibility. Why is that important? It’s important not only to understand the concept but to budget for it. So while nobody could estimate what real estate taxes are going to go up because it’s the city of New York, you could look back at the history and sort of say, okay, over the last X amount of years, taxes has gone up Y percentage?

So that in your budgeting, before you take occupancy and sign a lease, you do understand that you’re going to be paying a portion of the taxes. If you’re on a five year lease, you’re going to be paying 4 years in escalations. So that’s something you should be budgeted for.