Hidden costs of occupancy

Hidden costs of occupancy

By Stephen A. Cross, CCIM

A cost is “hidden” if it is not disclosed, discussed and negotiated prior to signing a lease or an amendment to a lease. The following are terms and lease provisions routinely overlooked by tenants and strategies to minimize their effects on the overall cost of occupancy.

Excess operating expenses

In full-service leases the maximum amount the landlord is obligated to contribute toward the operating expenses of the building is tied to either a “base year” or an “expense stop,” with the “excess” amount collected from tenants via a year-end reconciliation. Strategy: Where a base year is used, specify that it be either the year occupancy occurs or the subsequent year. When using an expense stop, make every effort to confirm that the landlord’s estimated operating expenses are lower than the expense stop.

Property taxes

Until buildings are fully assessed, the property taxes are understated – and can be expected to increase substantially. Strategy: Because it takes a year or more for newly constructed or recently sold buildings to be reassessed, I suggest designating the first year the property has been fully assessed as the property tax component when determining expenses attributable to the landlord.

Operating expense adjustments

When renewing a full-service or modified gross lease, be certain to reset the base year to the first year of the renewal period, or increase the expense stop to the most recently incurred amount. As operating expenses can be reasonably expected to increase by 3 to 5 percent per year and are cumulative, failing to make these adjustments can cost a tenant a substantial sum.

Poorly defined triple net (NNN) and pass-through expenses

Make certain that the historical and projected operating costs are properly disclosed and documented. Strategy: Include language in the lease capping these expenses at the amount represented by the landlord or its agents, with minimal annual increases on controllable expenses. Also, clearly define capital expenses in the lease and specifically exclude them from the expenses to be passed through to tenants.

Management fees

Management fees are a controllable expense. A 5 percent fee is reasonable, although many landlords attempt to increase their revenues by assessing tenants a 12 to 15 percent property management fee. Strategy: Stipulate a maximum percentage or amount in the lease. In the event tenant improvements are being performed cap the landlord’s construction management fee at 2 percent.

HVAC expenses

Make every effort to have the landlord warranty the heating, ventilation and air conditioning systems for the entire term. This is especially important for triple net leases on buildings older than five years (where the manufacturers’ warranty on the compressor has expired). Strategy: If a full-term warranty is not obtainable, request limiting the tenants’ out-of-pocket expenses for the repair or replacement of the air conditioning units to $300 to $500 per year (not per occurrence).

After-hours electrical usage

Full-service buildings generally provide electrical service and air conditioning and heating during “normal building hours” as part of the lease rate. Strategy: If you work late or on weekends from time-to-time, or seasonally, negotiate defined “after hours” usage at no cost.

Covered parking charges

Request covered parking for free or at a greatly reduced rate. Also, limit the landlord’s ability to increase charges for covered/reserved parking spaces during the initial lease term and any exercised option periods.

Free rent should be free

Make certain all costs of occupancy (including triple net expenses) are abated during the fixturization and free rent periods.

Holdover penalties

Limit the amount the landlord can increase your rent in the event you remain in the premises after the lease has expired. If the landlord has consented to a holdover, or if you are in the process of negotiating renewal terms, I suggest no increase be imposed. Otherwise, limit the increase to 25 percent above the last amount due under the lease.

Option period rental rates

When crafting option period rental rates, I suggest referencing the asking rates for similar buildings – the “market rate” – less incentives generally available to new tenants in an arm’s length transaction, which can include, among other things: a lower rental rate, minimal escalations, rental abatements and tenant improvement allowances.

Percentage rents

Many retail leases require the tenant to pay additional rent once a threshold of gross sales has been achieved (the “breakpoint”). Strategy: A method to effectively eliminate percentage rent obligations is to negotiate an artificial breakpoint, one that is substantially higher than the natural breakpoint.

Hidden agendas

When it comes to controlling the costs of occupancy-savvy decision makers, anticipate where economies can be achieved and pay attention to the smallest of details. However, if your core business is not commercial real estate, then you may have reasonably relied on those who hold themselves out to be experts in the field to advocate on your behalf and protect your economic interests.

In the event you selected a real estate agent whose representation skills fell short, and their negligence is costing you money, they may have overstated their experience and expertise or breached their perceived fiduciary duty to place your interests above all others. Strategy: Perhaps it’s time to sit down with the agent and their designated broker to discuss the matter. You may discover that the person you confided in and trusted to advise you was not an expert after all and/or was really working for the landlord’s benefit… and hid these disclosures from you.

Stephen A. Cross, CCIM, owns CROSS Commercial Realty Advisors and is a licensed real estate Broker. Mr. Cross advocates exclusively for tenants and buyers and, since 1984, has advised over 2,700 business owners, attorneys, physicians, facility executives, investors and corporate decision-makers on ways to lease and purchase property at the lowest cost and most favorable terms. Contact: 480-998-7998 or steve@crossrealty.com.