Ask a corporate real estate person what is the most confusing and contentious aspect of an office lease, and the answer will almost always be the operating expenses section.
All commercial leases contain at least a few paragraphs of language on how the operating expenses are handled. Many tenants enter a lease believing that the rent is the rent, but landlords want a mechanism by which they can pass on increases in the expenses to run the building. This language can be confusing and contain opportunities for unexpected rent increases to a tenant. Here’s how that works.
In the Boise market, office space is usually leased under full service contracts: Operating expenses like property tax, real estate insurance, utilities, maintenance, and janitorial services are included in a tenant’s rent. But the contracts also establish what’s known as a “base year” for these services and provide for additional rent charges if costs rise.
Usually the base year is the first year of the lease. Let’s say in the first year (or base year) of a lease, the building your company occupies costs $100,000 to operate and you occupy 10 percent of the building. In that base year, the landlord spent $10,000 on your portion of building expenses. As long as the building’s operating expenses stay at or under that $100,000 mark, your rent will remain at the number specified in your original contract.
If, however, one year the landlord spends $110,000 to operate the building and you still occupy that 10 percent, your portion of the expense jumps up to $11,000. Under the additional rent clause, you will receive an invoice for an extra $1,000 a few months after the end of that year.
In the following years, landlords usually estimate a continuation of higher operation costs and incorporate that estimate into monthly additional rent payments, adjusting as necessary.
There’s ample room for confusion and contention with the “base year of full service” contract. For example:
- If the tenant did not receive guidance from a real estate advisor or legal counsel when reviewing the lease contract, the additional rent invoice can be a surprise. Once explained, a negative tone is often set as the tenant may wonder what else may be lurking.
- Operating expenses are often broadly defined, including language such as “expenses include but are not limited to…” Be sure your landlord can’t take his office out to the ball game on your dime!
- The year chosen for a base year matters. For example, if a building’s taxes are based on its under-construction value in the base year, additional rent will skyrocket once the completed building is assessed and taxed. Or if a landlord puts off a planned expenditure for another year knowing your company is establishing its base cost in the current year, again, you’ll incur significant additional rent charges when the landlord finally initiates the outlay.
The operating expense provision of a lease can impact an annual rent obligation significantly, whether expected or not. So how does an office tenant address these concerns?
First, be sure you fully understand the additional rent provisions of your lease and how the invoicing is handled. Also, be sure to employ a competent tenant representative when securing a lease. And be sure to have your legal counsel review the lease in detail prior to signing it. These professionals can advise you on protections and exclusions you can put in place to better manage these variable and uncertain costs. Capping the allowable percent increase in controllable costs and setting base years appropriately are ways to manage these costs. Also, what if costs go down? Do you get the benefit of that reflected in your rent?
Most leases will allow a tenant to audit the accounting of these expenses. If you have questions or concerns about your ‘additional rent’ invoice, call us at TRA. We’ll find you some answers.