Operating Expense Protection
Definition: Operating Expenses are the costs associated with the operation and maintenance of a commercial building.
When signing a lease, don’t just consider what is included and excluded from operating expenses, also pay attention to the things that can help reduce the amount of operating expenses you pay each year. These operating expense reducers will not be in a standard form lease that the landlord presents, so it will be up to you will need to bring them up.
1. Make Owner ‘Gross-Up’ Certain Costs During Base Year
As a building’s occupancy rate rises or falls, certain operating expenses rise and fall, too, depending on the number of occupants in the building. These “occupancy- dependent” operating expenses may include such costs as electricity, garbage removal, and HVAC. The occupancy fluctuations can lead to big increases and declines in total operating expenses, which are the sum of the occupancy-dependent operating expenses and also non-occupancy-dependent operating expenses—that is, those that don’t rise and fall with occupancy. If you have a base year lease (or “modified gross lease”), it is not fair for you to pay a lot more or less, however, just because the building’s occupancy rate changes. You are still getting the same services, no matter how many other spaces are occupied. Grossing-up is a method that can prevent these big variations.
When an owner grosses-up, it determines how much each occupancy-dependent operating expense would be if the building were nearly full—for example, 95 percent full. This evens out the occupancy dependent operating expenses in base year leases so they don’t fluctuate with changes in the building’s occupancy rate. If you have a base year lease and are paying your proportionate share of operating expenses over a base year, make sure that, during the base year, the owner grosses-up:
- All occupancy-dependent expenses; and
- The costs of all services and utilities that other tenants are paying separately—such as tenants paying their electric bills directly to their utility company. If those expenses and costs are grossed-up only after the base year, but not during the base year, you could end up paying a share of huge increases in operating expenses over the base year.
2. Don’t Let Owner Profit
The owner should not make any profit from operating expenses. Therefore, include a clause prohibiting the owner from collecting an amount greater than your fair share of the operating expenses. Finally, try to eliminate any catch-all phrases in the definition of operating expenses that let owners back in additional operating expenses not specifically set out in the lease. Examples of such phrases include: “any other cost or expense of operating or maintaining the Property,” and “expenses paid or incurred by owner for the operation of the Property, including without limitation…”
3. Limit Controllable Expenses
Try to place an annual cap on increases in operating expenses that the owner can control—such as building personnel salaries, building service contracts, and management fees. Otherwise, these expenses could get out of hand and you could end up having to pay your share of a huge bill. For instance, add the following language to your lease, but make sure you define “Controllable Expenses” elsewhere in the lease.
4. Get Audit Rights
Make sure you include a clause in your lease that gives you the right to audit, review, and challenge the owner’s calculation of operating expenses. That will help keep the owner honest, and it gives you the right to obtain a refund for any overcharges. Here is a short checklist to run through each time you negotiate for audit rights.
- Detailed statement: Require the owner to deliver to you within 30 days to 60 days after the end of each lease year a detailed statement of its actual operating expenses for the prior year. You don’t want the owner to drag its feet in giving you this information, especially because the statement may indicate that the owner overcharged your operating expenses.
- Get refund of overpayment: If the statement from the owner shows that the actual operating expenses for the prior year were less than what you paid, the owner should promptly refund your overcharge.
- Get enough review time: Make sure the owner gives you enough time to review its statement of operating expenses, so that you can decide whether to challenge it typically, if you don’t challenge an owner’s statement within a set period of time, you will be deemed to have accepted it and will lose your right to challenge it. Therefore, try to give yourself at least 90 days to review the owner’s statement and decide whether you want to dispute it.
- Get access to books: Require the owner’s books and records to be available to you at reasonable times and at reasonable locations. For instance, if your lease is for space in Florida and the owner’s offices are based in California, it would be a long haul to the West Coast. In fact, that scenario would probably discourage you from exercising your audit right.
- Get owner to pay your costs: If the owner has overstated operating expenses by at least some threshold amount—usually between 3 percent and 5 percent—require the owner to pay for your audit costs. Further, if you have enough leverage in the lease negotiations, fight for the right to receive interest on all overcharges.
- Submit disputes to arbitration: If you and the owner can’t agree on whether there has been an overcharge or undercharge of operating expenses, get the right to submit the matter to a mutually acceptable arbitrator or mediator.
Content is provided by SwiftLease leasing agents.