Generally speaking, when we talk about lease payments, this means a fixed amount as a lease rate. However, in the Graduated Lease, the payment is variable or depends on periodic appraisals of the property. Or both parties agree to adjust the monthly payment periodically. So, if the value of the property increases after the appraisal, the landlord can increase the monthly payment.
The increase in payment may also depend on a change in the reference interest rate, such as the CPI (Consumer Price Index). We can also say that in this lease, the tenant agrees to make adjusted monthly payments, such as lease payments for a showroom, depending on market conditions, sales turnover, property value, etc.
This type of lease is common in long-term leases, and we call this type of lease as the graded lease.
Trigger for Graduated Lease
The two parties may decide to adjust the monthly payments at one of the following trigger points:
Escalator Clause
An increase in the lease payment depends on a change in the economic index or a benchmark rate. For example, on CPI, 10-year U.S. Treasury Bond, or more. We call this clause an index clause.
Reappraisal Clause
In this case, the rental payment may increase after the annual appraisal of the property. Thus, if the property’s value increases, the rental payment also increases.
Also Read: Lease Payment
Participation Clause
In this case, the tenant may have to contribute to the increase in real estate-related expenses such as taxes, maintenance, and more. However, the tenant may limit his liability by an expense stop clause.
Step-up Lease
In this lease, the provision for increasing the monthly payment is part of the contract. In addition, such a clause can be used to increase the monthly payment for assets that depreciate in value, such as equipment. This type of lease is beneficial for a start-up as it could help the company avoid purchasing the new equipment. In addition, the owner of the equipment is also fine, as he would receive more rent after a set period.
Graduated Lease – Whom it Benefits Most?
A graduated lease is built to benefit both the tenant and the landlord. But not both at the same time. In some months, it could benefit the landlord, and in some months, tenants could benefit from this.
In the long run, however, the owner benefits because the value of the property tends to increase over time, allowing the owner to charge more rent. Or we can say that lenders receive the payment at the market rate, regardless of the payment at the beginning of the contract.
Also Read: Lease Finance vs. Term Loan
On the other hand, it can be of more use to the tenant in the short term because he gets the property at a discount.
It is not wrong to say that graduated leases work better for real estate agreements than leasing of equipment. This is because the value of the property increases over time, unlike that of equipment. Similarly, this type of leasing will not work for cars, as the value of a vehicle declines over time.
Similarly, lenders do not typically offer graduated leases against depreciating collateral as this would benefit the borrower.
