Resources | Working Capital | June 8, 2023

How to Prepare For and Manage a Rent Increase for Your Business

Changing economic conditions could trigger commercial rent increases, but taking proactive steps now can help you minimize the financial impact on your business.

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Rent is a significant expense for many small and midsize businesses, regardless of the type of space leased. When it increases for reasons beyond your control, managing the cost can be a challenge. Market demand and economic conditions, such as record-high inflation and rising interest rates, can cause commercial rent to skyrocket. Businesses that are unprepared can struggle to keep up with rent payments, so it’s important to take proactive steps to prepare for and manage increases.

In this blog post, we will explore factors that can influence the cost of commercial rent and provide you with helpful strategies to mitigate the impact of rent increases so your business can remain financially stable.

How the economy impacts commercial rent

The state of the economy can have a substantial influence on commercial real estate and, therefore, rental costs. For example, low interest rates can make it cheaper for investors to borrow money to purchase or develop commercial real estate, which can increase the supply of available space and put downward pressure on rents — good news for businesses that rent commercial space. Conversely, with rising interest rates, it may become more expensive for investors to finance new commercial developments, leading to a limited supply of available space and higher rents. Furthermore, economic growth and business performance can affect the demand for commercial space, which can drive rents up or down.

Is commercial rent a fixed or variable expense?

You can consider your business’s rent a fixed expense if your lease agreement specifies a preset amount of rent that remains constant over the lease term. This means that you are required to pay the same amount of rent each month, regardless of changes in business activity or sales.

However, if your lease agreement includes a rent escalation clause or variable rent structure, your rent could increase over the term of the lease, making it a variable expense. While some leases contain variable elements, such as a percentage increase for inflation, this isn’t common. As a result, rent is typically considered a stable and consistent cost within a business’s budget.

What is a rent escalation clause?

A rent escalation clause is a provision in a commercial lease agreement that allows the landlord to increase the rent over the course of the lease. It usually specifies the method and frequency of rent increases, which can be for various reasons, such as changes in the Consumer Price Index (CPI), property taxes or the landlord’s operating expenses.

Generally speaking, rent escalation clauses protect landlords from rising costs and inflation, while also providing tenants with some predictability regarding future increases. If you are negotiating a lease, it is critical to be aware of the clause and carefully review the terms to ensure you understand how your rent increases will be calculated and when you can expect them to occur.

What can you do to prepare your business for a commercial rent increase?

While rising rental costs can be daunting for small businesses, there are several strategies you can use to lessen the uncertainty. Here are a few things you can do:

Review your lease

Before signing any new lease, ensure you review the terms and conditions carefully. Some leases may include clauses that limit how much the landlord can increase the rent each year or require them to provide advance notice. If this is the case, you’ll likely have more bargaining power if your landlord tries to increase the rent beyond what’s allowed in the lease.

Negotiate with your landlord

If you receive notice of a rent increase, the first step is to talk to your landlord. Many landlords are willing to negotiate on rent increases, especially if you’re a good tenant who pays rent on time and takes care of the property. You can also ask for a longer lease term in exchange for a smaller rent increase or request that the landlord include additional services, such as utilities or parking in the rent.

Evaluate your space needs

Conduct a periodic evaluation of your space needs to determine if your current rental is still the best fit for your business. If you’re not fully utilizing the space or can operate with less space, downsizing may be an option. Alternatively, if you have unused space within your leased property and your lease allows it, you may be able to sublease it to another business to help cover the cost of a rent increase. If your business has outgrown its current space, it may be time to consider relocating to a larger space or negotiating a lease with an option to expand. 

Reduce operating costs 

If you’re unable to negotiate a lower rent, you can always explore ways to reduce your operating costs to counter the cost of the increase. For instance, you might re-evaluate staffing levels, reduce energy usage, cut unnecessary expenses or change vendors. By cutting down on your expenses, you can help to ensure your business remains profitable despite the rent increase.

Maintain control of your cash conversion cycle

Your cash conversion cycle is the amount of time it takes your company to convert investments in inventory and other resources into cash inflows from sales. Increased costs such as a rent hike can affect the cash you have available for other uses. 

However, there are many ways to reduce liquidity risk and ensure your cash cycle remains manageable in this scenario. For instance, you could accelerate accounts receivable, negotiate longer payment terms with vendors, reduce inventory levels or implement cost-cutting measures to optimize cash flow and offset the impact of rent increases.

Leverage an early payment program

Another way to mitigate the effects of higher rent is to optimize working capital by leveraging early payment programs provided by enterprise buyers

Early payment platforms, like C2FO’s Early Pay solution, enable you to offer a dynamic discount in exchange for faster payment, improving your access to working capital without accumulating debt. Using C2FO’s online platform, you can view outstanding invoices, select which ones to accelerate, set a discount rate and receive payment upon approval. 

These programs differ from traditional supply chain financing because they don’t rely on third-party institutions, which ensures their sustainability during crises.

In summary

Navigating rising costs, including rent increases, is an unavoidable part of running a resilient and successful business. Economic conditions, demand for commercial space and rent escalation clauses in lease agreements can all contribute to unexpected rent increases. 

By carefully reviewing lease agreements, negotiating with landlords, optimizing cash flow, evaluating space needs, reducing operating costs and leveraging early payment programs, your small or midsize business can offset the impact of commercial rent increases and remain financially stable.

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