Operating cost exclusions in your commercial real estate lease

by | Blog, Leasing

  1. General Exclusions

The tenant needs to understand what he or she is paying for to ensure that he/she is not being overcharged by a landlord who is trying to turn operating expenses into a profit center. Landlords might put language into the lease allowing for: 

  • Charging the cost of capital expenses and improvements when they occur
  • Including charges specific to one tenant through to all tenants
  • Charging a management fee or administrative fee (or both!) that are not market rate

Here are some areas where a reasonable landlord will negotiate in a commercial real estate lease:

  • Leasing commissions, legal fees, promotional costs, etc.
  • Charges relating to sewer or water connections
  • Entertainment or travel expenses
  • Cost of repairs, replacements, etc. covered by insurance
  • The cost of any alterations or improvements due to construction defects or compliance reasons
  • Repairs due to condemnation or casualty
  • Costs related to lease negotiations or disputes
  • Correcting a tenant violation of a lease
  • Depreciation 
  • Costs of renovating, redecorating or improving a space
  • Amounts paid to landlord-related parties for services that are above the market rate
  • Salaries of landlord employees that are mangers
  • Landlord’s general overhead and administrative expenses
  • New or additional structures
  • Capital expenses
  • Income, excess profits, franchise, transfer, estate or inheritance taxes 
  1. Capital Expenditures

Capital expenses are not capital improvements.  A new roof or air conditioner are not repair or maintenance items, but are capital improvements that benefit the project. These capital expenses often have a useful life beyond a tenant’s commercial lease term. Landlords like them because they are needed and it may increase operating expenses on a go-forward basis. Tenants don’t want to pay for more than their share of these expenses. A typical example is a replacement HVAC unit. 

The best way to resolve this is to compromise.  The tenant will pay for capital expenditures that reduce overall operating expenses, but those costs are amortized over the useful life of the improvement. 

  1. Management Fees

Another potentially expensive section is the issue of the management fee for the project. Landlords may hire an affiliated party to manage the property. There’s no guarantee that the rate being paid to the property manager is market rate, or that the landlord isn’t padding operating expenses and keeping the difference.

There are a couple of different ways to address this.  One solution is to specifically state that whoever the landlord hires as the property management company, that entity will not be paid more than the market rate.  Another solution is to simply to cap the cost of the management fee, usually as a percentage of the gross rent for the building. 

 

NEGOTIATION TIP: Watch out for a commercial real estate lease that charges an administrative fee AND a management fee!  It doesn’t matter how it’s calculated, it’s usually a landlord attempt to collect twice on the same charge. A good commercial real estate attorney can help the tenant negotiate to control this cost.

 

  1. Controllable Operating Expenses

Finally, another way to avoid overcharging for operating expenses is to cap the increase for “controllable” operating expenses. Controllable expenses typically excluded insurance, real estate taxes, and specific other items that are beyond the landlord’s control.

How do you know what other controllable expenses are?  Need help understanding the different fees and how to negotiate them?  Hire a commercial real estate attorney, who knows what to look for and will advocate for your best interests.

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