By Rick Pearson, Cresa
In most “gross” leases, there is a provision whereby the tenant is responsible for increases in operating expenses. In office space, it’s known as either a “Full Service Gross Lease” or a “Modified Gross Lease.” In industrial, it’s just called a “Gross Lease.”
Although some landlords don’t charge their tenants for these increases, many do. Since the calculations are cumbersome and the concept is difficult to grasp, I see many mistakes made, which can result in tenants paying more than they are required to pay.
The first step to verifying the accuracy of the increase is to verify the accuracy of the figures and methods used to determine its bases. Here’s what you’ll need:
- Base Year (either a calendar year or other period of time)
- Base Year Expenses (broken down into categories, i.e., taxes, insurance, janitorial, R&M, etc.)
- Average Occupancy During the Base Year (for multi-tenant office projects)
- Percentage Share of the Building (What percentage of the building does your premises occupy?)
- Comparison Year Expenses (broken down into the same categories as the Base Year, above)
- Average Occupancy During the Comparison Year
If these items are not provided by the landlord or property manager, ask for them.
It is very important to see how much each category of expenses increased during the Base Year. Often, the landlord will give you the total expenses for the Base and Comparison Years, calculate the difference, and then apply your Percentage Share to that figure. But that information alone is insufficient. Only once you can see how much each category increased, can you ask some of the following relevant questions:
Have the property taxes increased by more than 2%?
- The primary reason property taxes would increase by more than this amount is due to a sale, but many leases indemnify or otherwise protect the tenant against property tax increases triggered by a sale.
- Many properties have sold at high prices in the past two years so the potential for property taxes to increase significantly is very real, and can be costly.
Are there increases in Repair and Maintenance costs (R&M)?
- Some R&M costs may not have anything to do with the general repair and maintenance of the property. For instance, new flooring in the common area lobby or major repairs to the mechanical system could be considered “capital improvements,” and should not be included in R&M. If R&M charges are substantial, it is worth investigating to learn exactly what they are, and to make sure they have been expensed correctly and are, indeed, subject to tenant reimbursement.
- Similarly, some R&M cost may result from a new tenant moving into the building. These are not operating costs and should be removed.
Are there increases in management, utility, and janitorial costs?
- We call these “variable expenses” which means that they increase and decrease based on how much space in the building is occupied. Most leases provide that these costs are adjusted to a 95% or 100% level. This applies to both the Base Year and the Comparison Year. The important thing to remember here: Just because the costs increase, does not mean you are responsible for your calculated share of them.
- This is the one areas where the calculations get difficult for both the property manager and for the tenant. Calculations must be based on Average Occupancy rates. But most Landlord’s don’t provide them; they may not even know them. If the landlord cannot provide the Average Occupancy rates used to calculate these variable expense categories, there is no basis for their increases, and he cannot charge for them.
- To further confuse things, landlords typically have the right to estimate these charges at the beginning of each year and then make an adjustment if needed at the end of the year. But remember:
- While you do not have the right to formally audit the estimated amount, you can ask for the back-up information that supports the estimate. Most likely, you are required to pay it and then question it when you finally get the reconciliation the following year.
- Be sure the landlord does a proper reconciliation the following year and makes all applicable adjustments.
In summary, be sure you have all the information to which you are entitled, so you can analyze the bases for the increase you are being asked to pay. Be sure you are actually obligated to pay for each portion of the increase, and be sure all of proper adjustments have been made. You have the right to receive a clear and detailed explanation from your landlord, with figures to back-up the calculations used to arrive at amount he’s asking you to pay. If you feel you haven’t: call me; I’ll try to help.