By Jeff Grandfield and Dale Willerton – The Lease Coach
As a commercial tenant, the monthly base rent you pay your landlord for leasing commercial space may not be the only rent you pay. Many commercial tenants will also pay a secondary amount for property operating costs. The good news is that both these rents are often negotiable.
To clarify, operating costs (also referred to as common area maintenance/CAM, triple net/NNN charges, or additional rent) are the costs of maintaining and managing a property. Examples of valid operating costs include property taxes, property insurance, maintenance, utilities, landscaping (which includes snow removal) and garbage collection. Valid operating costs will benefit all of the tenants in a commercial property—not just one or two. Commercial tenants need to understand and remember that operating costs are charged proportionately to all tenants. Therefore, a tenant occupying 7 percent of a commercial property will, typically, pay 7 percent of the total operating costs.
Operating costs are not, however, used equally. For instance, we are familiar with one tenant who created only one bag of garbage per week. He chose to load this bag into his own van, take it home, and place it outside with his own trash. Despite this, he was still obligated to pay his proportionate share of operating costs. In this case, it may be possible to exclude these charges for an individual tenant who can argue they are receiving no benefits from such operating costs.
Any costs that are not covered by the commercial tenant’s contribution to operating expenses become the responsibility of the landlord. Understandably, landlords want to ensure that tenants’ fees cover all the building costs. What is wrong, however, is when all the tenants within a commercial property are paying needlessly to subsidize capital improvements on the building. The capital improvement costs could mean the construction of a new building or the installation of new pylon signs on a property when none existed before.
Another common scenario when operating costs can increase dramatically is when a new landlord purchases a building that has much deferred maintenance to be completed. The landlord’s motivation to complete this maintenance is to charge higher rents and fill vacancies, but this comes at the expense of higher operating costs for the current tenants. Commercial tenants should be looking at other similar buildings in the area and seeing what their operating costs are. If operating costs at one particular building are quite low and the property appears in need of updating, it is reasonable that these costs may rise significantly in the future.
A commercial property’s operating costs need to be completely spelled out in a tenant’s lease agreement. When this occurs, a tenant can examine, question and negotiate each listed item. Beware that commercial landlords can be quite creative when it comes to listing operating costs; we have seen cases where landlords require all of their tenants to pay an annual fee to have a pool of money available for damage not covered by insurance. In most of these cases, the tenants were required to pay this fee for the entire duration of their tenancy. If damage occurred during a tenancy, a landlord will tap into this reserve fund; if a tenant has relocated, the money that he/she paid into the pool was not refundable.
When a building is fully occupied (or close to fully occupied), the landlord may be less motivated to try to charge tenants more than their fair share. Prior to signing the lease, a tenant must ensure that there is no language within the lease permitting the landlord to charge back shares of operating costs for any vacancies to the tenants currently occupying the property. Even if your lease does not permit this, tenants must review their operating statements closely every year to ensure that they are not absorbing operating costs that should be attributed to any vacancies.
When it comes to deciphering operating costs, read carefully! These are a few of the potentially detrimental issues that can negatively affect commercial tenants:
Administration/Management Fees: If tenants are paying the property manager’s salary through operating costs, but the landlord adds a further 15 percent management 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, it may be possible to exclude these items from the fee, 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 be 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 your 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. Your lease should include tenant audit rights, which allow you to examine the landlord’s books, if necessary.
