Rent is Rent is Rent. Or, is it?

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Rent is such a simple thing. It is covered in every lease. Those who draft leases get told how much the rent will be and that’s it. After all, “rent is rent.” It’s just a number. So, why is Ruminations about to talk about rent? To find out, read on.

In olden times when leases were not much more than an exchange of money from a “tenant” to a property owner (landlord) for an interest in real property, i.e., for an estate of limited duration, things were much simpler, so to speak. In essence, a lease was a document of conveyance and the rent paid for the right to exclusive possession of the leased property for a stated term, much like the purchase price for a deed. [That’s all we are going to say, today, about the mix of conveyance theory with contract theory that underlies today’s leases.]

Today, rent pays for a whole bundle of things. In exchange for paying rent, a tenant may get exclusive use rights, promises that the lights will stay on, air conditioning, and lot and lots of non-possessory rights, the total value of which package is reduced by obligations undertaken by the tenant. When it comes to leases, as with most things in life, everything has a price. Simply put, though not often thought about, a lease giving a tenant an exclusive use right is more valuable to a tenant than the same lease without that exclusive use right. So, it should cost more. To save time and words today, we’ll let readers expand on that example with their own thoughts.

It doesn’t really matter how valuable a particular lease may be to a particular tenant. What matters is the rent the “market” sets for any particular set of leasing terms (including those “bonus” rights and non-possessory features). This shouldn’t be a radical concept. It doesn’t matter how much the landlord needs to pay its bills or how much the tenant can afford to pay when it comes to determining the amount of rent to be charged. If there were ten identical spaces (think peas in a pod condominium units being rented to residential tenants) and everyone had perfect knowledge in a fully transparent marketplace, the rent for each would be identical.

When a landlord proposes a rent figure or a tenant makes an offer or a broker opines as to what the rent should be, each is making an assumption about what a perfect market would “say.” In fact, if everyone knew everything there was to be known about the marketplace, no discussion would be needed.

We know that the vast majority of readers are chomping at the bit to shout out, “No, that’s not true.” Hold your horses (hence, the bit reference). Ruminations knows that when it comes to real estate pricing, we really have a very imperfect market. Yes, parties are of unequal knowledge. There are some payers (tenants) who, even knowing that the requested rent is more than what the market would say, just plain need that particular space and are willing to pay more than 100 other tenants would be willing to pay just to be “there.” None of that, however, dissuades us from reiterating that the market sets the rent, not any individual player in that market. If perfectly suitable spaces in the relevant market were all two dollars per square foot less than what a particular landlord was asking, who but an unknowing tenant or one that couldn’t use the other spaces would pay the premium? Similarly if 100 tenants were willing to pay “market” price for a landlord’s space, what landlord, knowing the market price, would take two dollars per square foot less from an unrelated party?

Now, let’s go back to the concept that, for a given rent, you get a given set of benefits. Take the case of two identical spaces, side by side. One is to be leased as a plain vanilla box (the “market” standard in that area) and the other is to be leased as a “turn-key” retail store. Would the rent be the same? Of course not. The market sets a lower rent for basic space than it does for improved space. Here’s how we think it works. The market sets more than the rent figure. It sets, or assumes, what one gets for that space. If a given market is known to offer certain amenities or features for rental apartments, such as cleaned carpets, repainting, and one month of free rent, then when brokers quote rental rates for five different apartments, those rates presume those amenities or features. Likewise, if the custom in a given area is to offer exclusive use rights to all retail tenants regardless of size or bargaining power, the quoted rents presume that such an exclusive use right is being given.

Let’s say that in another way and in another context. Here is a common scenario in a single market area where both retail space in shopping centers is available and office space in decent size buildings is available. When you hear a rent quote for the retail spaces, it almost always assumes that the tenant will pay all taxes and operating costs on top of its rent. But, when you hear the rent for the office space, you can expect that today’s taxes and operating expenses are already in the base rent and that the tenant will only pay increases for those items.

Now, how does that play out? Here’s one example. Let’s say the market rent is $30 per square foot and that assumes a $20 per square foot fit-up allowance. When a landlord says that the allowance is on a “use it or lose it” basis or that it can only be used for real property improvements, what should happen if the tenant only spends $10 per square foot? Some would say, “Tough luck.” But that’s not the way it should be. To explain why Ruminations feels that way, we’ll return to some earlier words: “the market sets a lower rent for basic space than it does for improved space.” A good rule of thumb is that for a ten year lease, every dollar per square foot of tenant allowance money is ten cents more per square foot. [If you really want to figure it out, treat it like a one dollar loan to be repaid at a market interest rate over ten years on a self-amortizing basis. Yes, the tenant allowance is really a disguised loan.] Using our far from nuanced one dollar equals ten cents formula, a lease with a $20 per square foot allowance costs two dollars more per square foot than one for the same space with no allowance. That’s right, there is no free lunch. So, if the tenant can only draw $10 per square foot of space under the landlord’s conditions, it deserves a one dollar per square foot rent reduction.

Here’s another implication of the “rent is two dollars higher because of the tenant allowance” math. Let’s say that the tenant under the hypothetical lease has negotiated for two successive 5- year extension options at a 10% rent increase at the start of each 5- year period. Should the 10% increase be based on the rent with or without the $2 extra amount embedded in it to cover the initial tenant allowance. We’ll leave that for readers to figure out. After you answer the question for yourself, ask yourself: “What did the market say about whether the 10% was to be on the already amortized tenant allowance rent component?”

Let’s get a little trickier. Take this set of assumptions. The market rent for a lease on what is commonly called a NNN (“triple net”) basis is $30 per square foot. Base year taxes are $5 per square foot and base year operating expenses are $3 per square foot. That means that, if the market quoted rent on what is commonly called a gross basis, the quoted rent would be the sum of those three figures, or $38 per square foot. If the market calls for 2% rent increases each year on NNN leases, why should the same percentage increase apply to gross leases? After all, the landlord is protected against tax and operating cost increases because the tenant, under a gross lease, pays the entirety of those increases. Again, what does the market say? Would a tenant always be better off insisting that the rent be on a NNN basis so that the rent increases would be on the true, underlying rent alone?

Now, to get into further trouble – if the rent could be either $30 per square foot (with all taxes and operating expenses extra) or $38 per square foot (all in), should there be a different leasing brokerage commission rate for NNN leases than for gross leases? We’ll translate that. If the market quotes “sets” one brokerage fee of 5%, should a landlord pay a commission of forty cents per square foot extra just because it quotes a gross rent ($8 above the $30 at 5% is forty cents)?

Yes, there’s a lot more than meets the eye when we agree on how much the rent is going to be. And, those who craft the documents, while bound by the agreed-upon numbers, shouldn’t assume that there is nothing to negotiate about when lease provisions are dependent upon, or related to, the “rent” number in the letter of intent.



  1. Speaking of rent, I just came across a renewal option clause in a NYC landlord’s form lease which states that: (a) the tenant’s exercise notice is void if NOT accomapanied by a check equal to 1 month’s rent at the rate in effect for the final month of the expiring lease term and (b) the check will be credited to the 1st month’s rent for the renewal term. Is requiring such a payment, together with the tenant’s exercise notice, similar in spirit to requiring the 1st month’s rent upon the tenant’s execution of the original lease for the initial term? Has anybody seen rent payment language like this before in a renewal option?

  2. Charles Izzo says

    I appreciate your analysis but economic theory would suggest that the first and the last of the the identical condominium units would bring different rents. The concepts of scarcity and oversupply are always tugging the price one way or the other. Think of airline seats.

  3. I find that Landlords believe in distinction to the point that the rent fits the tenant. there may be many choices and much supply, but of exactly what “you” need? It’s virtually unique. In fact, the space that you currently occupy, that your customers know to look for you there, and that you’ve spent to improve to your corporate standard IS unique. While the spaces are purely interchangable from a “rational” point of view–same four walls, same heat, same merchantability, their entire buisiness is to drive distinction (that only 10% of the retail space in a market is suitable for YOU) which is why many cheaper markets run from 10/SF to 35/SF–thats a 350% variation that gets you anywhere from an empty center next to the dead mall to the tony new outdoor mall development 3 miles away. It is a case of “rich man’s medicine” as in the chinese proverb–a rich man has a very certain digestive system see–he cannot take the base, cheap cure–his must be customized and exotic and therefore expensive as suits him. No doubt there is distinction from the worst to the best, but national tenants can only accept the best–and that represents a much narrow conception of supply and therefore a tiny cross section of the market willing to suit that industry and also the capacity of deep pockets to pay for the innumberable small expensese and large associated with tenancy, the immense legal and tail cost risks, buildouts, etc…which makes it clear why one-off brick and mortar stores are almost impossible to economically rationalize in 21st century america.

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