Graduated Lease

Graduated lease refers to an agreement under which a tenant and landlord agree to a periodic adjustment of monthly payments. In general, this means an increase in the tenant’s payments due to either market conditions or an increase in the value of the leased property.

A graduated lease tends to benefit the property owner over the long term, but the arrangement offers advantages to both landlord and tenant. A graduated lease allows the property owner or lessor the opportunity to charges increased rent as property values increase over time. The tenant or lessee is able to take possession of a property at what may be a discounted rate in the short term. This can often help during the ramp-up stage of a new business venture.

Graduated leases are also known as graded leases. Graduated leases tend to structured for longer terms than traditional straight or fixed leases, whose terms are typically one to two years.

From a lender’s perspective, a graduated lease is a better fit for real estate leases than equipment leases due to the tendency of real estate values to appreciate over time. A lessor would be unlikely to offer a graduated lease on an automobile, for instance, since the value of a car depreciates steadily over time. This depreciation could lead to decreasing monthly payments.

Traditionally, adjustments in graduated leases result from one of four factors:

• Many graduated lease agreements contain an escalator clause triggered by a rise in an economic index. This can also be known as an index clause. The Consumer Price Index (CPI) or 10-year U.S. Treasury Bond are common benchmarks. When prices rise, the landlord can raise monthly lease payments.
  

• A lease agreement may also contain a reappraisal clause which allows for a hike in rent following an annual appraisal of the property. Again, this is likely only to result in an increase in rent.
  

• A participation clause can force the tenant to contribute to increases in expenses such as utilities, taxes or maintenance. These hikes can be limited by an expense stop provision.
  

• A step-up lease is a form of graduated lease in which increases in rent are built into the agreement, and may be used for the lease of an asset that will depreciate in value, such as machinery. A start-up may enter into a step-up lease to avoid large payments up front, in anticipation of future cash flows arising from use at the equipment that will allow them to cover larger payments in the future.