Real Estate Tax Escalations For New Buildings Can Be Full Of Surprises

Commercial leases for occupancy often require the tenant to pay a percentage of increases in real estate taxes imposed on the owner’s building, to the extent those taxes exceed the taxes in a base tax year. That base tax year is sometimes the tax year when the parties sign the lease, sometimes the next tax year, sometimes the tax year when the property owner delivers the leased space to the tenant, sometimes the tax year when the property becomes “stabilized,” and sometimes a combination. It’s a negotiation.

By helping to insulate the owner from increases in real estate taxes, a tax escalation clause helps the owner preserve its anticipated return from its real estate investment. That predictability appeals to lenders, allowing an owner to obtain maximum loan proceeds. Tenants agree to this arrangement as part of the horse trading that determines their initial rent and other economic terms of their lease. They hope that as real estate taxes go up, so will their revenue. Sometimes tenants also negotiate for the right to share in the savings from tax abatements available to the owner.