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The following expenses are normally considered part of the definition of operating expenses in a commercial lease: ownership, management, maintenance and operating costs; insurance premiums and deductibles; wages, salaries and benefits of building personnel; management fees; service contracts; supplies and equipment; repairs and maintenance; decorating; security; snow and ice removal; and utilities for the common areas.
The manner in which operating expenses are defined in a lease will go a long way in determining just how much of a “profit center” the operating expense clause can be to a landlord.
Given that the operating expense clause can often operate as a “profit center” for a landlord, tenants need to be aware of the many holes and landmines contained within them. At worst, any item of a capital nature should only be included based upon the remaining term of the lease to the useful life of the capital expenditure itself based on Generally Accepted Accounting Principles (GAAP), and not on a useful life “as [reasonably] determined by landlord in its sole discretion.”
A tenant advocate should aim to keep the definition of operating expenses within the lease as broad as possible.
In most circumstances, an operating expense definition includes a number of costs that are capital in nature and built-in profit components for the landlord.
In almost all situations, tenants should simply agree to the operating expense clause in the lease without attempting to negotiate the definition of operating expenses.
From a landlord’s perspective, a landlord’s operating expense definition within the lease should include as many items as possible.
To make a landlord’s operating expense provision appear impartial, landlords should list some exclusions to the definition of operating expenses in the initial lease draft.
In the letter of intent, tenants should include language reflecting that tenant reserves all rights to negotiate operating expense definitional exclusions during lease negotiations.
A tenant should always include an expansive list of operating expense exclusions in the letter of intent.
Tenants should make sure that there is no “double dipping” of any item deemed to be an operating expense that tenant is required to pay under any other section of the lease.
If a tenant is paying its share of operating expenses over a base year, tenants should add “gross up” language that provides that the base year operating expenses shall be determined as if the building is 95% occupied and landlord is supplying services to 95% of the rentable area of the building.
If a tenant is paying its share of operating expenses over a base year, tenants should try and negotiate that in no event shall their initial payment occur prior to the twelve (12) month anniversary of the rent commencement date.
Most landlord advocates prefer an operating expense escalation as opposed to that of a CPI or straight predetermined percentage bump in rent because landlords use the operating expense escalation as a profit center by including as many expenses as possible in the definition of operating expenses.
If the landlord elects for a percentage rent increase over that of an operating expense escalation, it is in the tenant’s best interest to have the increase applied every five (5) years, as opposed to annually.
In the aggregate, it is less expensive for a tenant to have to pay a rent increase annually, rather than one applied every 2-5 years.
Tenants should agree to language within the lease that any capital expenditures or any cost that is capital in nature, including the costs of any capital improvements, alterations or replacements made to the building or the property, are the tenant’s responsibility.
Generally speaking, landlords are in the business of leasing out their space for profit and tenants are in the business of leasing out space from landlords to conduct their business operations in order to make profit.
From a tenant’s perspective, the useful life of any capital expenditure should be determined by the Generally Accepted Accounting Principles (“GAAP”) and not on a useful life “as [reasonably] determined by landlord in its sole discretion.”
For those landlords willing to agree to the the following language, the cap should be applied to both controllable and uncontrollable costs: “Notwithstanding anything to the contrary contained in this lease, in no event shall tenant’s obligation to pay its pro rata share of operating expenses over the base year operating expenses increase by more than five percent (5%) over the tenant’s pro rata share of the increase for the prior calendar year.”
If the landlord gives the tenant the right to audit their books in relation to an operating expense escalation, it would be in the landlord’s interest to state that the “Tenant shall be required to (a) hire a national, regional or local CPA and (b) not use a firm which will charge tenant for its examination services on a contingency basis.”
The following is an operating expense exclusion that a tenant should include in its lease: “Costs, including permit, license and inspection costs, incurred with respect to the installation of tenant improvements made for new tenants in the building or incurred in renovating or otherwise improving, decorating, painting or redecorating vacant space for tenants or other occupants of the building.”
The following is a reasonable item for a landlord to include in the operating expense definition within a lease that a tenant advocate should not attempt to negotiate out of the lease, “Rent for landlord’s on-site management or leasing office, or any other offices or spaces of landlord or any related entity.”
In regards to the operating expense definition, a tenant should agree to the inclusion of costs incurred by the landlord due to violations by the landlord of any governmental rule or code.
It is not in the landlord’s best interest to agree to an operating expense definition which includes any capital expenditures or any cost that is capital in nature, including costs of any capital improvements, alterations or replacements.
When negotiating the definition of operating expense, tenants should attempt to exclude late charges, interests, penalties and assessments on any charges payable by landlord which are included within operating costs.
Within an operating expense provision, it is customary for a tenant to pay for wages and benefits of any employee not attributable to the building, but under the supervision of the landlord.
Tenants advocates should consent, without hesitation, to the costs of any above electrical usage by any other tenants in the building to be included within the operating expense definition.
Tenants should negotiate that any cost of extra HVAC, janitorial or other extra work provided to the tenant in non-business hours to be excluded from the operating expense definition.
In most instances, the tenant has very little leverage in excluding advertising and promotional costs associated with the leasing of the building and the costs of signs in or on the property identifying the owners of the property or any tenant of building from the operating expense definition.
In regards to operating expenses, tenants should agree to pay organizational expenses associated with the creation and operation of the entity that constitutes the landlord.