The structure of commercial leases in South Africa is fairly unconventional compared with the rest of the world. In South Africa, most commercial lease agreements include annual rental escalation clauses.
Generally speaking, commercial leases in Europe and North America don’t feature rental escalations. Instead, rentals are usually fixed with periodic reversions to market on a cyclical basis.
In South Africa, rental escalation clauses originated out of a need to protect Landlords against rising inflation that was experienced in the 1970’s. However, thirty plus years later, inflation levels in South Africa have been on the decline for a sustained period – and yet rental escalations on commercial leases remain. Why is this?
By raising nett rentals on an annual basis, Landlords are able to increase the value of their property assets by continually expanding their income stream. We would assume the continued existence of escalation clauses locally make economic sense to all market participants and that no unwarranted influences exist on the part of Landlords.
In our experience, local commercial property landlords tend to negotiate lease deals at below market rental rates, with a view to ramp up yields over the term of the commercial lease via rental escalations. These leases are usually concluded over periods of three to five years.
These types of below market commercial lease profiles are becoming increasingly prevalent in the current tough economic climate, and there are benefits for both Tenants and Landlords. These benefits include:
- Tenants achieve ‘below market’ rentals at the commercial lease’s inception.
- Tenants are able to budget for rental escalations in the medium to long term.
- Rental escalations allow landlords to steadily increase rental streams over the lease period which in turn increases asset value.
- Landlords avoid income erosion should market conditions drive property costs upwards.
When rental escalation clauses do come into play, the Consumer Price Index (CPI) is one of the globally accepted indices for determining market related escalations. Rental escalations based on CPI are there to assure the landlord’s rental streams while avoiding possible income erosion during the term of the commercial lease.