Triple Net Leases: Allocating Maintenance Expenses Among Tenants
Besides insurance and taxes, a net lease obligates tenants in multi-tenant situations to pay a portion of the landlord’s operating costs. This is your share of the cost to maintain the building’s upkeep, including common areas such as lobbies, hallways, garages, and elevators. You may also be asked to contribute a proportionate share for the building-wide air and heating costs (called HVAC, for heat, ventilation, and air-conditioning). If you lease space in an office building, there may be an added management fee, which will cover the cost of the building’s superintendent or the monthly amount the landlord pays a management company to run the building. All of these costs are part of the landlord’s ongoing operating expenses.
You’ll confront two major issues when negotiating the maintenance clause: What portion of the upkeep costs will be paid by the landlord, and what by the tenants; and further, how should the tenants share their portion among themselves? Nolo’s article, Dividing Maintenance Costs Between Landlord and Tenants, explains the first issue; this article concerns the fair allocation of costs among tenants.
Allocating Variable Operating Costs Among Tenants
Operating costs, like taxes and insurance costs, are sometimes easy to allocate fairly. Roof upkeep, systems repair, and so on benefit all tenants, and dividing the cost among them according to the space they rent makes sense. But the same isn’t true for variable costs, such as electricity, gas, and water.
If you’ve read about the fair allocation of taxes and insurance, you probably know the issue: If all tenants in the building exert an equal “draw” on the variable services, it makes sense to charge them according to the portion of the building they lease. For example, in a retail building with four shops, each business probably uses the common areas, parking lots, heat, and electricity in roughly the same way. Sharing these costs according to the size of the tenant’s space would be fair. The situation is different, however, if there’s a mix of tenants, some of whom use more of the common areas than others.
The best solution is having the space submetered, but rental space in office buildings and some retail buildings usually won’t be submetered. That’s because the boundaries of each rental often change, depending on how much space the current tenant has leased. For example, the third floor may belong to one tenant during one rental term, but then be leased out to two or three smaller tenants after the first one has moved out. The landlord will not want to reposition utility meters every time he reconfigures space to suit tenants’ needs.
In the absence of submeters, Landlords often establish a “building usage standard,” which is their calculation of the cost of each utility per square foot. Tenants are then charged according to the amount of space they rent. But this method fails to address the main challenge: Tenants don’t use utilities at the same rate. For example, a computer business that’s small in square footage but crammed with electricity-guzzling equipment will devour much more than its neighbor whose cavernous quarters are used to display artwork. If utility costs are allocated according to square feet rented, the art gallery will end up paying more than its fair share.
Negotiating Your Fair Share
Be on the lookout for possible disparities of use among the tenants in your building. If everyone is in the same line of work (a building full of dentists, for example), it’s more likely that the usage will be uniform than if there is a wide mix of tenants. If you do suspect that another tenant’s utility use will be disproportionately high (or that yours will be disproportionately low), press for an adjustment in the allocation of utility charges to reflect reality.
Unfortunately, if there are tenants in place already, you’re likely to hear the same objection you’ll encounter when pressing for equitable insurance allocations: Even a sympathetic landlord can’t shift operating costs to utility-devouring tenants if their leases already specify that costs will be shared based on their portion of the rentable space. And the landlord won’t be eager to absorb the difference himself. You may have to make a note of this inequity and use it to press for another concession from the landlord, such as reduced rent or an extra parking space.
“Grossing Up” Provisions in a Net Lease
Unless you rent an entire building, you’re likely to encounter this odd term during your discussions of operating expense allocations. The term describes how landlords allocate a tenant’s share of operating expenses when the building isn’t fully leased. Done right, the method ensures that tenants pay their fair share of operating expenses. But on first blush, it seems unfair. Trust us, it’s not.
Suppose you rent one floor in a ten-story building, where all floors are the same size. You have 10% of the rentable space, and the other nine floors are empty. Now suppose you use $100,000 worth of electricity during the first year, while the rest of the building remained empty. If you were to pay for the cost of electricity based on your percent of the rentable space, you’d pay only $10,000, and the landlord would be left to pay the rest (which neither he, nor anyone else but you, used).
To remedy this inequity, when calculating your share, landlords will assume that the building is fully rented (“grossed up”), and that everyone uses the same amount of electricity that you do. In that event, the electricity bill would be $1,000,000 (ten floors of ten tenants each using $100,000 worth of electricity per year), and your ten-percent would mean that you’d pay $100,000—exactly the amount you in fact used.
Grossing up is appropriate only for variable expenses (expenses that rise or fall with the level of occupancy), such as the cost of cleaning, utilities, some repairs, and maintenance. Fixed costs that don’t vary with the level of occupancy, such as the landlord’s insurance premiums or the cost of a nighttime security guard, should not be grossed up. For instance, if your lease obligates you to pay 10% of the landlord’s property taxes, that’s all you should pay, regardless of whether the property is fully leased.
This article was excerpted from Negotiate the Best Lease for Your Business by Janet Portman