There are expenses included in a commercial lease agreement that can be controlled, because they can be competitively priced or bid upon by competing companies. These include services like landscaping, repaving a parking lot, or trash removal. The landlord should be able to get accurate and competitive pricing for work such as replacing a roof, paying its property management employees, or its costs for security patrols, if any. The landlord can either have a contract in place with controlled pricing, which would be for a frequent, predicable service, such as lawn care or holiday lights decorations, or should be able to bid out an anticipated cost, such as painting the building or replacing signs.
Other costs are harder to control, usually because of the conditions surrounding how they are incurred. For example, snow and ice removal is rare in the southern part of the United States, and it’s not a cost a landlord would commonly account for in its budget. In the north, everyone needs snow and ice removal at the same time, and the needs can vary from year to year (or week to week!), so that’s difficult to budget for accurately.
Each landlord and each management company will vary, but the most common costs that are exempt from the definition of “fixed” are: taxes (these are set by the authority that levies the taxes) and insurance (commercial insurance rates generally do not vary greatly across providers), utilities (in many areas, there is only one provider of utilities, such as water, natural gas, or electric power, and those are fixed by the provider), and snow and ice removal (weather is so unpredictable, it’s impossible to know exactly how often the services will be needed).
Tenant Control Costs
A tenant can also do its part to control its costs, or at least create some predictability in these costs. A large tenant that occupies a lot of space might have a ground lease or an absolute net lease, where the insurance, tax and operating expenses are paid directly by the tenant to the provider, which would give the tenant, and not the landlord, the authority to negotiate prices.
A smaller tenant would need to create some predictability about the costs that it pays. One way is to “cap” cost increases. This means that the tenant will pay a certain percentage increase year over year, but even if the costs are more than what was predicted, then tenant isn’t responsible for more than that percentage increase of the controlled costs. A 5% CAM cap means the CAM costs increase 5% annually, even if landlord’s costs increase by more than 5%. This allows the landlord to account for increases in costs while incentivizing minimizing those costs.
Setting a Base Year
Another method is to set a “base year.” The first year of rent does not include any additional costs- they are included in the rent. Then, the tenant only pays the increases, not the actual cost, during the term of the commercial lease. So if the NNN costs are $1.00 per square foot in the first year of the lease, the tenant doesn’t pay any additional NNN costs. In the second year of the lease, if the NNN costs are $1.17 per square foot, the tenant only pays the $0.17 per square foot increase.
Costs always increase, it’s just the way it is, but the landlord and tenant can work collaboratively to keep the costs under control and create stability and predictability for both parties. The tenant will also want an audit right in its commercial real estate lease, which means that at the end of the year, the tenant receives a bill and can reconcile between what was billed and what was paid. If the tenant suspects an error, it can audit the landlord’s books, and in the event of an incorrect payment, the landlord should refund any overpaid amount to tenant’s account.
The Law Office of Jenna Zebrowski, PLLC can help you control your costs in your lease! Sign up for your no-obligation discovery call today!