In addition to taxes and insurance, there is a third ingredient in a net lease—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? This article discusses the first issue; see Nolo’s article, Triple Net Leases: Allocating Maintenance Expenses Among Tenants, for a discussion of the second issue.
Pass-Throughs and Exclusions
Landlords and tenants debate endlessly over what, exactly, should be included in the operating costs. Landlords will bargain for a clause that makes the tenants pay for as much as possible. In fact, the list of charges that are “passed through” to you is often modified with those slippery words “Tenant will be responsible for the following costs, without limitation ….” The effect of “without limitation” is to make it possible for the landlord to tack on extra charges. Tenants, in turn, will press for enumerated exclusions. Your negotiations over operating costs will pit the “pass throughs” against the “exclusions.”
Listing excluded items in the lease is just one approach to dealing with this issue. Even better is to agree to a specific list of items that the landlord can include—and to state that anything not mentioned is the landlord’s sole responsibility.
Typical Pass-Throughs and Exclusions
Here’s a list of items that a landlord may consider to be operating expenses that can be passed through to you. You may want to negotiate to exclude some of these items, such as advertising expenses and legal fees.
- Accounting fees
- Travel expenses for landlord and employees
- Legal fees
- Office rental for landlord’s office
- Security services
- Major improvements to building -(capital expenditures)
- Real estate commissions
- Janitorial expenses
- Association membership fees
- Management fees
- Parking lot repaving
- Light bulb replacement
- Salaries for landlord’s employees
- Advertising expenses
- Inspection fees
- Maintenance supplies
- Broker fees
- Deductible amounts for insurance claims.
Allocating Operating and CAM Costs Between Landlord and Tenant
One sensible way to separate costs that should belong to the landlord from those that rightly belong to tenants is to ask whether the expense is for a capital improvement—a replacement of a structural element of the building, or an improvement that adds lasting value—or is associated with the day-to-day running of the property. Unfortunately, there is no clear and widely accepted understanding of the difference between a capital expense and a noncapital expense. Tenants argue that the costs of maintaining the structure or roof and bringing the building up to code are capital and should be entirely the landlord’s responsibility. The costs of servicing the heating and air-conditioning and maintaining the building’s electrical equipment are maintenance items that reasonably can be passed on to tenants.
Some landlords attempt to charge tenants for fairly outrageous items, including leasing commissions, other tenants’ improvement allowances, and legal fees occasioned by other tenants’ misdeeds. Landlords have very creative ways to bulk up their list of maintenance expenses. For example, capital improvements that have the effect of lowering your operating costs may be shoved your way.
Many capital improvements will also benefit the landlord (and future tenants) long after you have moved out. And if your lease expires soon after you’ve paid the bill, the benefit you will have received from these improvements will be small indeed. For example, if the landlord puts in building-wide sprinklers during the last year (or security features such as locks, better doors, or windows), you’ll get socked with the pass-through but have very little time to benefit from them.
To guard against last-minute pass-throughs that you won’t be around to enjoy, press for the right to amortize, or spread, the cost of the expense over the useful life of the item. The landlord is likely to counter with, “amortized over the useful life, or five years, or over the length of the remainder of the lease, whichever is shorter.”
Because payments on a leased item, such as a car, are clearly considered operating expenses, a smart landlord will lease an item—rather than purchase it—in order to pass through the cost of the payments. Ask the landlord whether her operating expenses include leased items—then bargain for them to be explicitly excluded from the pass-throughs.
Your landlord’s deductible amount is a favorite inclusion in the list of pass-throughs (this is the amount not covered in the event of a claim on the landlord’s insurance policy). To keep premiums low, deductible amounts can be quite high. For earthquake and terrorism insurance, for example, they may be 5% to 10% of the replacement costs.
Protect yourself by bargaining for the amortization of these costs. For support, point to the fact that, under general accounting principles, you’re entitled to amortize the cost (passed on to you) of repairs. Because paying for the deductible is not much different than paying directly for repairs, it too should be amortized.
This article was excerpted from Negotiate the Best Lease for Your Business by Janet Portman