When tenants negotiate leases or amendments, many fail to carefully review the operating expense provisions. If a tenant fails to read the fine print, it may receive a large, unexpected bill. With most companies striving to reduce overhead and manage expenses, unexpected five-figure operating expense true-ups are very unwelcome. Two areas tenants should review to mitigate risk are:
- Capital Expenses. Some leases will permit the landlord to pass through capital expenses to tenants. These can range from the replacement of component parts of the HVAC system to the replacement of the roof. Tenants should limit capital expenses to only those expenses 1) resulting from laws promulgated or made applicable to the project following the date of the lease or 2) incurred primarily to reduce the cost of or avoid increases in operating expenses; such expenses should be amortized over the useful life of the item.
- Expense Caps. Many tenants negotiate a cap on controllable operating expenses. Although these appear to prevent unexpected increases in operating expenses, the definition of “controllable operating expenses” may render the cap worthless. Typically, non-controllable expenses are taxes, insurance, utilities, government mandated wage increases, and snow/ice removal. Some landlords will insert the right to determine what constitutes a controllable operating expense, which effectively destroys the negotiated cap. Tenants should carefully negotiate what is excluded from the definition.
Although a tenant’s negotiating strength will ultimately depend on the amount of space taken its credit-worthiness, informed negotiation may mitigate the potential for a large year-end bill.