Keep these two important issues in mind as you head into lease negotiations:
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A property’s tax bill is calculated by multiplying the local tax rate by the property’s assessed value. Depending on where the property is located, you might have a city (or town) and county tax rate applied to the property’s bill. You might also see additional fees, such as police department, fire department, and solid waste costs.
Sometimes the tax rate is shown as a percentage. For example, suppose the county tax rate is 2%. If your property is worth $200,000, then your tax bill will be $4,000, or 2% of $200,000.
Other times, the tax rate is shown as a fraction of a dollar per every $100 of your property’s assessed value. For instance, suppose your county tax rate is $0.65 per $100 of your property’s value, and your property is assessed to be worth $100,000. So, you would owe 65 cents for every $100 your property is worth. To calculate your tax bill, you’d divide your property’s value by 100 and multiply that number by 0.65. So your tax bill would be $650, or $100,000/100 x 0.65.
You can check with your city or county’s tax office to find out how your tax bill is calculated.
If you’re going to be the landlord’s sole renter, it won’t be hard to allocate the tax burden between the two of you. Depending on who has the superior bargaining position, either you’ll get stuck with:
While taxes can be divided multiple ways between the landlord and tenant, there are two methods often used—sometimes together—in triple net leases.
A common way to place tax responsibility on the tenant is for the landlord to agree to pay all real property taxes for the first year of the lease (sometimes called the “base year”). Then, after the first year, you pick up all or a portion of any increase in the property tax.
For example, suppose Spartan Enterprises leases a small building from Urban Developers for five years. The lease says that in years two through five of the lease, Spartan will pay 50% of any increase in real property taxes beyond the first year amount.
Taxes are $3,000 for year one and are paid entirely by Urban. In year two, taxes go up to $3,300. Spartan owes $150 in real property taxes in year two (50% of the $300 increase). Urban pays the remaining $3,150.
A landlord might, however, ask you to pay for more than just the tax increases. You could be asked to pay for all real property taxes, or to split real property taxes 50/50 with the landlord. A shrewd landlord could also set the base year several years in the past—when the tax bill was lower than it is now—so that you immediately begin paying the increase.
If you’re going to pay all or a part of the landlord’s real property taxes, it’s important that the lease clause specify that you’ll pay according to your percentage of the property’s total rentable space—not the space that happens to be rented when you sign your lease.
If you pay according to the total space that happens to be rented at the time, you can end up paying an enormous portion of the tax bill if there are significant vacancies in the building.
For instance, suppose California Sew and Vac rented 2,000 square feet of the total rentable area of 10,000 square feet in Larry Landlord’s building. Sadly for Larry, only half of the total space (5,000 square feet) is actually rented out. Sew and Vac has a triple net lease that obligates it to pay for a portion of Larry’s property taxes.
There are two ways to compute Sew and Vac’s portion of the taxes:
You can see why a landlord would prefer to base your tax responsibility on the rented—not rentable—area of the building. Under the first system, the landlord will pass the risk of an empty building onto the tenants—whoever’s there will divide the bill among themselves. Under the second system, however, the landlord will pay taxes for the unrented space.
If you see (or expect) significant chunks of vacant space in the building, try hard for a lease clause that bases your share of taxes on the building’s rentable space. If it’s a hot property with vacancies unlikely and apportionment is based on rented space, you won’t have much to worry about.
When you negotiate the lease, ask to see the landlord’s property tax bill for the preceding year. If you’re asked to pay all or a portion, you’ll know the amount—for now. But it’s not likely to remain static. The tax amount could rise because:
For these reasons, it’s great to get a binding promise that you’ll be excused from paying taxes over a stated amount. This guarantee will protect you from additional taxes if a reassessment or building sale results in higher taxes.
In a multitenant building, many tenants can share the tax burden. In a property with other tenants, you might have neighbors who’ve put in expensive, value-adding improvements, such as:
(Improvements are permanent additions to the landlord’s property, as opposed to trade fixtures that tenants usually remove when the tenancy ends.)
You, on the other hand, might end up adding little or nothing to the value of the property when you move in, asking only for a new carpet, paint, and some special lighting. What’s the problem?
Your landlord’s real estate tax bill is based on the taxable value of the entire property, which is computed by considering the sum of all tenants’ improvements. Suppose your tax obligation is based on your pro rata share of the rentable space, without taking into consideration the fact that your neighbors’ valuable improvements have upped the tax bill significantly. In that case, you’ll be paying more than your fair share.
One way to even things out is to bargain for your tax obligations to be based on your pro rata share of the taxable value of the entire property, instead of your pro rata share of the entire rentable space. That way, you pay according to the value of your space.
It’s unlikely that you can get the tax assessor to separately value individual tenants’ spaces in a commercial building. The best way to estimate your fair share of taxable value is to:
Suppose a small strip mall in Pacific Cove has three commercial spaces and 10,000 square feet available.
Tenant A leases 2,000 square feet for an auto repair shop. A adds a hoist, automatic garage doors, a heavy-duty ventilation system, and extensive electrical wiring, all of which became permanent improvements, to their shop. Rebuilding this space would cost $150 per square foot.
Tenant B leases 5,000 square feet to use as a distribution center for dry goods. B adds nothing to the bare space when they moved in. To rebuild would cost $50 per square foot.
Tenant C leases the remaining 3,000 square feet and adds interior walls and some lights for use in their telemarketing business. Rebuilding costs for this space would be $65 per square foot.
The tenants all have triple net leases, which are all up for renegotiation.
Table 1, below, shows what happens to each tenant’s tax obligation if it’s figured on the basis of that tenant’s portion of the rentable space only. In this table, the rent isn’t adjusted for the individual value of each tenant’s space.
Table 2 shows what happens to each tenant’s taxable share when the landlord figures it according to the value of each tenant’s rented space. In this table, the tenants’ improvements are accounted for in the rent calculation.
Tenant |
Rented space (square feet) |
Rentable space |
Ratio (rented space/rentable space) |
Tenant’s share of the taxes |
A (extensive improvements) |
2,000 |
10,000 |
20% |
20% of the total |
B (added nothing) |
5,000 |
10,000 |
50% |
50% of the total |
C (moderate improvements) |
3,000 |
10,000 |
30% |
30% of the total |
Tenant |
Replacement cost per square foot |
Rented space, square feet |
Cost to replace own space |
Replacement cost of entire property |
Tenant’s share of replacement costs |
Tenant’s share of the taxes |
A (extensive improvements) |
$150 |
2,000 |
$300,000 |
$745,000 |
40.3% |
40.3% |
B (added nothing) |
$50 |
5,000 |
$250,000 |
$745,000 |
33.6% |
33.6% |
C (moderate improvements) |
$65 |
3,000 |
$195,000 |
$745,000 |
26.1% |
26.1% |
As you can see from comparing the results of Tables 1 and 2, the tax burdens on A, B, and C will be quite different if the landlord allocates them according to the value each has brought to the property, instead of the size alone of their rentals.
Tenant A in particular, who brought in many expensive improvements, will pay twice as much according to the replacement value method. If you happen to be Tenant A, no doubt you’ll prefer the system shown in Table 1—but it wouldn’t be the fairest way of dividing the tax burdens.
When you negotiate with the landlord over how taxes are allocated among tenants, remember that it must be the same for all tenants in the building. The landlord will be constrained by the terms of the leases already in place with other tenants. Absent some extraordinary clout on your part, it’s unlikely you’ll be able to accomplish this.
Returning to our previous example, suppose Tenants A and C are already renting under triple net leases that allocate taxes according to the size alone of their spaces. Tenant B won’t be able to press for a replacement value system unless they can get the landlord and A and C to rewrite A’s and C’s leases. Tenant B could potentially convince C, but they’d have a hard time getting A on board when it means that A would be doubling their share of the costs.
However, there’s no reason why the system has to remain the same forever. If you have a lease that’s longer than other tenants in the building, press for a planned switch to a value-based method when all existing tenants are out. Negotiate for a promise from the landlord that all new tenants will be given space-based tax obligations only until all space-based tenants have left. At that point, all of you will convert to a value-based system.
When you’re calculating the property taxes and each party’s fair share, it can be hard to coordinate the appropriate distribution method. If you and your landlord are at odds or you and the other tenants favor different allocation methods, it can be a good idea to reach out to a contracts lawyer that has experience with commercial leases. An attorney can walk you through the pros and cons of each valuation approach and help you and the other side reach a fair agreement.
]]>You’ll want to negotiate each of the three areas of costs under your triple net lease. For maintenance expenses, you’ll define your share of the costs under your lease’s maintenance clause.
You’ll confront three major issues when negotiating the maintenance clause of your commercial lease:
Maintenance costs include the cost to maintain the building’s upkeep, including common areas such as lobbies, hallways, garages, and elevators. You might also be asked to contribute a proportionate share of the building-wide air and heating costs.
If you lease space in an office building, there could be an added management fee. This fee 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 maintenance expenses, and many are passed through to the tenant.
The landlord could consider any of the following to be maintenance expenses:
Landlords and tenants debate endlessly over what, exactly, should be included in the maintenance expenses under the triple net lease.
Your negotiations over maintenance costs will pit the “pass-throughs” against the “exclusions.”
Pass-throughs. The landlord will usually list the charges that are passed through to you—the tenant. But this list is often modified with the 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.
Exclusions. The tenant, for their part, will usually press for specific exclusions to maintenance costs, such as advertising expenses and legal fees. Alternatively, the tenant can negotiate for the landlord to make a specific list of maintenance items that the tenant is responsible for. Then any item not mentioned will be the landlord’s sole responsibility.
One sensible way to determine who—the landlord or tenant—should be responsible for a specific maintenance cost is to ask whether the expense is for:
Unfortunately, there’s no clear and widely accepted understanding of the difference between a capital expense and a noncapital expense.
A tenant might argue that the costs of maintaining the building and roof structure and bringing the building up to code are capital costs and should be entirely the landlord’s responsibility. A landlord might argue that the costs of servicing the heating and air-conditioning and maintaining the building’s electrical equipment are maintenance items that can reasonably 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.
You can follow these negotiation tips, below, to avoid burdensome expenses being passed from the landlord through to you.
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 could be shoved your way.
Many capital improvements will also benefit the landlord (and future tenants) long after you’ve moved out. And if your lease expires soon after you’ve paid the bill, the benefit you’ll 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.” The less you can pay over the course of your lease, the better.
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 their operating expenses include leased items. Then bargain for any leased items to be explicitly excluded from the pass-throughs.
Your landlord’s deductible amount is a favorite inclusion in the list of pass-throughs. The deductible 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, the deductibles could 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 isn’t much different than paying directly for repairs, it too should be amortized.
Operating costs, like taxes and insurance costs, are sometimes easy to allocate fairly. Roof upkeep, systems repair, and similar core maintenance projects 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.
You’ll need to determine the best solution to portion out your fair share and negotiate for your preferred expense distribution with the landlord. You should also prepare for complicated scenarios, such as when your solution conflicts with other tenants’ leases or the building isn’t fully leased out.
Fixed costs don’t vary with the level of occupancy, such as the landlord’s insurance premiums or the cost of a nighttime security guard. Variable costs rise or fall with the level of occupancy, like the costs for cleaning, utilities, and some repairs.
If all tenants in the building equally use 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. In this situation, there are some potential solutions to divide the cost between tenants.
The best solution is to have the space submetered. If each rented space has its own meter, then it’s easy to charge each tenant for their individual usage.
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 might 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 they reconfigure the 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 power 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.
When negotiating your own triple net lease, factor in 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’s 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 themselves.
You might 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.
Unless you rent an entire building, you’re likely to encounter the odd term “grossing up” 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—including maintenance—expenses. But on first blush, it seems unfair. Trust us, it’s not.
For example, 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 they nor anyone else but you used).
To fix 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 10% would mean that you’d pay $100,000—exactly the amount you in fact used.
Grossing up is appropriate only for variable expenses; fixed costs shouldn’t 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.
Negotiating a triple net lease that’s fair and manageable is crucial. The terms of the lease that you bargain for now will likely remain in place for the life of your lease and you’ll be expected to abide by them—good or bad.
If you have any questions about your lease, particularly what maintenance costs you’re responsible for, you should reach out to a real estate lawyer with commercial lease experience. They can help you negotiate a fair allocation of maintenance expenses and prepare you for expected costs under your triple net lease.
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