Base Rent, Escalations and Free Rent Explained

Base rent is the amount you pay the landlord for the right to occupy the space. It is separate from the building costs that may be billed on top of it, such as operating expenses, real estate taxes and electricity. When a listing or a broker quotes a rate, that rate is almost always base rent.

The convention that surprises first-time tenants is the unit. In most United States office markets, rent is quoted as an annual amount per rentable square foot, not as a monthly check. Some markets quote monthly instead. A founder comparing spaces in two cities can be looking at numbers that are not on the same basis at all, so the first question about any quoted rate is what period and what square footage it applies to.

The second question is what the rate includes. The same number means very different things depending on the lease structure.

• A gross or full-service rate generally bundles the building's operating costs and taxes into the rent, often with you paying future increases over a starting year.
• A net rate covers the space only. Your share of operating expenses and taxes is billed separately on top.
• A modified gross rate sits in between, with some costs included and others billed to you. The lease defines which.

Rent is also multiplied by rentable square feet, which includes a share of the building's common areas, not just the area inside your walls. Two suites that feel the same size can carry different rentable figures.

Very few multi-year leases hold rent flat. The lease will contain a rent schedule or an escalation clause that raises base rent, usually once a year on the anniversary of the start date. Landlords use escalations to keep pace with rising costs and to protect the value of the building. For a tenant, the escalation is part of the price, and it compounds.

There are three common ways an escalation is written:

• Fixed percentage increases. Rent rises by a stated percentage each year. Because each increase applies to the prior year's higher rent, the later years of a long lease cost noticeably more than the first.
• Fixed dollar steps. Rent rises by a stated amount per square foot each year. This is simple to model and does not compound the same way.
• Index-based increases. Rent adjusts with a published inflation index. This shifts inflation risk to the tenant and makes future rent uncertain, so tenants often ask for a ceiling on any single increase.

The escalation is negotiable, like most business terms in a lease. It is also easy to overlook, because proposals tend to put the starting rate in the first line and the escalation further down. A lower starting rate with a steeper escalation can cost more over the term than a higher rate that rises slowly.

Ask for the full rent schedule, year by year, for every proposal. Compare the totals, not the first-year rates.

Free rent, or rent abatement, is a period during which the landlord waives rent. It is one of the main concessions landlords use to win tenants, alongside a tenant improvement allowance. It helps a growing company with cash flow at exactly the moment it is paying for a move, furniture and equipment.

The details decide how much the concession is worth.

• What is abated. Often only base rent is waived, and you still pay operating expenses, taxes and utilities during the free period. Some deals abate the full gross payment. The lease should say which.
• When it applies. Abatement is commonly placed at the start of the term. It can also be spread across the term or placed at the start of later lease years, which changes the cash flow benefit.
• Whether it is conditional. Many leases make abatement conditional on the tenant not defaulting. Some let the landlord recover the abated rent if the tenant later defaults, so have your attorney review that language.
• How it interacts with other rights. If your lease includes an early termination option, the landlord will usually want the unrecovered value of free rent and other concessions repaid as part of the termination fee.
• Whether the term is extended. Landlords sometimes add the free period to the end of the term so they still collect the full number of paid months.

Free rent generally grows with the length of the commitment and the strength of the tenant's credit. A venture-backed company with a short operating history may be offered less abatement, or be asked for a larger security deposit in exchange for it.

Two dates in a lease are easy to confuse. The lease commencement date is when the term starts and your obligations under the lease begin. The rent commencement date is when you start paying rent. They can be the same day, or the rent commencement date can fall later, after the free rent period or after the build-out is complete.

Check how each date is defined. If rent commencement is tied to a fixed calendar date and construction runs late, you can end up paying rent on space you cannot use, or burning free rent while contractors are still working. Tenants generally want rent to start only once the space is delivered in the agreed condition, with delays caused by the landlord pushing the date back. Escalation dates matter too. If increases run from lease commencement, the first increase can arrive while you are still in the abatement period.

A quoted rate is a single point on a long schedule. Two buildings quoting the same rate can produce very different total costs once escalations, abatement, the lease structure, the tenant improvement allowance and the measured square footage are taken into account. Brokers reduce all of this to a net effective rent, which spreads the concessions across the term so that proposals can be compared on one basis.

You do not need to build that model yourself to ask the right questions. Before reacting to a rate, get answers to these:

• ✓Is the rate quoted per year or per month, and on rentable or usable square feet?
• ✓Is it gross, modified gross or net, and what is billed on top?
• ✓What is the escalation, how is it calculated, and when does the first increase take effect?
• ✓How much free rent is offered, and does it cover base rent only or the full payment?
• ✓Is the abatement conditional, and can the landlord recover it after a default?
• ✓When does rent commence, and what happens to that date if the build-out is delayed?
• ✓What is the total rent payable over the full term under this proposal?

This is the routine work of a tenant representative. We put every landlord's proposal on the same basis for our clients so the decision is made on total cost and flexibility, not on whichever building advertised the lowest starting number.