What happens when commercial rent increases?

by Corben Grant on 12 Jan 2022

One major cost that all businesses need to contend with is the cost of commercial space itself. For any business owners who don’t own their own property, they will probably be renting from a landlord for their business space. As one of your major expenses, your rent cost will represent an important part of your financial accounting as you strive to keep your business profitable. Unfortunately, as anyone who has ever run a business can tell you, the prices of things are changing almost every day and rent is no exception.

Though you likely have some sort of agreement with your landlord that outlines how much your rent will cost, this amount can change over time. Luckily, the amount that your landlord increases rent will generally be incremental so you won't be blindsided by a huge increase.

For both landlords and tenants, it’s important to know the basics of how rent changes.

Average commercial rents in Canada

In recent years, there have been a lot of challenges in the commercial real estate space. For one, there are large trends that are changing the sorts of real estate that are in demand.

One of the biggest is the rise of online business, as well as giant retail companies that are both working to push out small retail businesses from commercial buildings. This means that the retail sector has seen some drop in demand while sectors like offices and industrial or warehouses have continued to grow.

There have also been major effects from closure and business interruptions as a result of the COVID-19 pandemic. Many businesses were forced to close or relocate with retail being hit the hardest of any other sector.

Non-retail rents surpassing pre-pandemic levels

The price of commercial rents has not followed a single simple path in recent years. While commercial rents were generally increasing in all areas into the start of 2020, they saw a large decrease from March 2020 onwards. Since then, commercial rents have been on a gradual return to their pre-pandemic levels, with both office space and industrial space now having regained their lost value. Only retail rent still remains below pre-pandemic levels.

This is important to note when looking at the average cost of commercial rent as you have some sectors performing better than others. The total average does not really tell the whole story of how different sectors are performing.

What is the average commercial lease increase per year?

The amount that commercial rents change per year will depend greatly on the specific market and economic conditions of the given time period, as well as the area in question. For example, Toronto and Vancouver commercial rents have tended to increase more than other areas.

According to commercial rents services price index data obtained from Statistics Canada, the average price of commercial rent on the national level has gone up about 1% per year for the past five years. However, this has not necessarily been a steady increase and different market sectors have displayed different rates of growth. Commercial rents in the retail sector have actually gone down over the last two years.

Meanwhile, when retail rents are excluded, warehouse and office rents have actually increased almost 4.5% in the nearly three-year period from January 2019 to September 2021

What are the rules for my rent increases?

Laws about commercial and residential leases differ

Unlike residential tenancies, commercial tenants usually do not have significant legal protection when it comes to rent increases. Generally, residential landlords have a limit on how high they can increase rent in a given year to keep the price of housing in pace with inflation as determined by the consumer price index.

This is because while residential housing is seen as a necessity and can present a power imbalance between tenant and landlord, in commercial tenancies it’s assumed that both parties are business people who have more knowledge when it comes to negotiating commercial leases.

As a result, as a tenant, your rent increases will ultimately be decided by two different things. One is the lease agreement you signed with your landlord and any provisions within that specify how rent increases are to be handled. The other is simply the market value of rent in your area.

Since a commercial lease is a legally binding agreement, you can basically count on your current rent to remain the same as long as your lease is valid. The only time you can get a rent increase is when your lease has run its course and is up for renegotiation.

However, even if the landlord chooses to raise rent at the end of the term, most leases allow the tenant the right to refuse the new rate and look for a new tenancy somewhere else.

Different kinds of escalation clauses

There may also be commercial rent escalation clauses in the lease terms themselves that dictate how a rent increase will be handled. A commercial rent escalation clause may be as simple as an increase at the end of term, a gradual increase to base rent over the lease term, a flat rate increase per square foot, or other kinds of clauses.

Why landlords raise rent

As a landlord, your decision to raise your rent will likely follow from an increase in your property's operating expenses. These can include any number of costs such as your mortgage, property taxes, property management, insurance and more.

How the market determines the price of rent

There is an average rent cost for each sector and each region that is referred to as the market rate. Tenants will generally leave properties with higher rents when they can receive lower rent for a comparable property nearby. Therefore the market rate is balanced through the interaction of property operating costs as well as tenant supply and demand.

Landlords naturally want to get the most out of their properties, but at the same time, they have an interest in keeping their tenants in business. A high rent value sounds good, but if it means your tenant can no longer do business, and therefore can not pay you at all, it won't really be worth it. There may even be cases where the landlord will negotiate rent with the tenant to reach a deal that will work for both.

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