Negotiating the Operating Costs as Rent
Readers of our new book, Negotiating Commercial Leases & Renewals FOR DUMMIES, will learn (in-part) that although most commercial real estate professionals may tell you that operating costs are not negotiable, there are aspects of these costs that can indeed be changed to the tenant’s favor.
When it comes to operating costs (also known as Common Area Maintenance / CAM charges), the landlord wants to make sure that the tenants pay all these costs for the building. There’s nothing unusual about that. However, when The Lease Coach analyzes operating costs for groups of tenants in a building, we often find that the tenants are subsidizing capital improvements that the landlord is using to enhance the building and/or property’s total value.
If a formal lease document uses sufficient detail to define what constitutes an operating cost, then the tenant has a fighting chance to at least examine, question, and negotiate each listed item. We remember one Florida landlord who charged all of his tenants an annual fee to have a pool of money available for hurricane damage not fully covered by insurance. We inspected closer and noticed there was no end to this billing or reserve fund … tenants were required to pay it for the entire duration of their tenancy. If a tenant moved out at the end of their lease term, they were not refunded any or all of the money they had paid – even if there had been no hurricane damage. In this case, this landlord was simply creating a slush fund to do with as he pleased.
The majority of commercial, office, and retail lease agreements may stipulate that the specific components of the operating costs that the tenants need to pay for. Typical examples of operating costs include general property maintenance, painting, lawn cutting, snow removal, property insurance, and so on. Remember, a valid operating cost is one that will benefit all of the tenants in the commercial property – not just one or two. Almost every lease agreement an operating cost clause and typically defines these common area maintenance charges in a short- or long-form manner - longer is better as it creates more certainty for you.
Operating costs are charged proportionately to all tenants. If one tenant occupies seven percent of a commercial property, he/she can typically be required his/her proportionate share – seven percent – of the operating costs as additional rent to the landlord. But not all tenants use operating costs proportionately. Would a convenience store or a bank contribute more to parking lot trash collection? Would a tenant on the first floor or the 20th floor of an office tower use the elevator more often?
We remember one dry cleaner who felt it was unfair that he had to pay his proportionate share of trash removal. He claimed that he created only one bag of garbage each week – he happily put this bag in his van, took it home with him, and then set it outside for pickup with his own household garbage. Yet he was forced to pay his proportionate share of trash removal just like all of the other tenants.
Is it possible to negotiate a cap on operating costs? Yes. In some cases, a slothful or cash-strapped landlord may have skimped on regular maintenance but after the property is sold to a more reasonable landlord several years’ of deferred maintenance has to be caught up on at the expense of the present tenants. If you are trying to budget annual costs, and your overhead rents are important to you, you may want to negotiate a 5 – 10 percent cap on operating costs so that your landlord can only raise them that amount annually as a minimum.
In response, your landlord may be willing to cap controllable operating costs – meaning that they won’t cap property taxes or other such items that are beyond their own management control. As a tenant, you may want to agree to this as a compromise – consider that any ceiling or restrictions that you can put on rising operating costs will ultimately benefit you.
Operating cost discrepancies come in two flavors: honest mistakes or dishonest (deliberate, negligent, or fraudulent) calculations. In a close to fully occupied or fully occupied building, the landlord may have less reason to try to profit from operating costs. Still, the landlord may try to enhance the property with the tenant’s money. On the other hand however, when a commercial property has a number of vacancies, the landlord may want to avoid paying his proportionate share of operating costs for the vacant units. Therefore, the landlord may put language into the lease agreement stating that the operating costs for vacant units may be passed on to the tenants occupying the building. Obviously, in some cases, tenants can be carrying a very heavy financial burden if the commercial property is not fully leased.
Communicating with the landlord (both verbally and in writing) about any operating cost concern(s) you may have is imperative. And don’t wait too long because the lease may stipulate a statute of limitations on adjustments. Sometimes the problem originates with the property manager but sometimes it comes from the owner or landlord purposefully taking advantage of the tenants in the property. Dale remembers his time as a commercial property manager when one landlord told him to find creative ways to charge every penny spent on the property back to the tenants. If you catch your landlord with his hand in the cookie jar, don’t be too surprised if he’s not communicative or cooperative with you.
Any number of other issues could be buried deeply within operating cost clauses. Be aware of the following several examples:
Administration Fees: If tenants are paying the property manager’s salary through operating costs, but the landlord adds a 15 percent administration fee to CAM costs, this can be considered double-dipping (or double-billing for essentially the same service). If the landlord levies administration fees on property taxes and/or insurance, note that can also be defined in the same manner as there is very little landlord’s administrative work involved with these.
Utilities: Electricity, natural gas, and water may be provided by the landlord or separately metered for each tenant. In some cases, the landlord may have one meter on the property and a check meter on each tenant’s unit to measure consumption. If you’re paying your own utilities to the utility company you’ll have your own meter. Often, the landlord bills back utilities to tenants in operating costs. Make sure that you know in advance what the lease agreement calls for so you don’t pay twice.
Tenant Audit Rights: The landlord has a fiduciary responsibility for accountability to the tenants for the money collected from and spent on behalf of the tenants. The lease should include tenant audit rights which allow you the opportunity to examine the landlord’s books, if necessary.
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Dale Willerton and Jeff Grandfield - The Lease Coach are Commercial Lease Consultants who work exclusively for tenants. Dale and Jeff are professional speakers and co-authors of Negotiating Commercial Leases & Renewals FOR DUMMIES Wiley, 2013). Got a leasing question? Need help with your new lease or renewal? Call 1-800-738-9202, e-mail [email protected] or visit www.TheLeaseCoach.com.