| About
the Author
Stan Mullin specializes in the sales and
leasing of industrial land and buildings in southern Orange
County, California. His areas of expertise include: entitlement,
contract language, construction schedules, development, assessment
district and community facility district bond financing.
Stan is also a respected author and
instructor for the Society of Industrial Realtors (SIOR) and the
American Industrial Real Estate Association. |
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Tips for Tenants – the lack of specifics can be expensive
Author: Stan Mullin, CCIM,
SIOR
Two months ago we ended our article on lease audit rights with a promise to follow-up by addressing the operating expense definition in a lease and the specific language that you should be aware of before committing to a lease. In this month’s article, we will address four such items. While our advice is based on our combined experience in representing clients in commercial real estate transactions, you should always consult with your broker and attorney when attempting to address these specific items in any proposed lease. Also, please note that due to space limitations, we can only highlight these issues for you at this time.
Before getting into those specifics, lets review why the definition of operating expenses is so important in a lease. The definition is important to you, as a tenant, because you are agreeing in the lease to reimburse the landlord, via several differing formulas, some portion of the expenses associated with “operating, maintaining, repairing, managing and owning” the building and related real property. Accordingly, the lease definition is the ultimate authority on what specific expenses the landlord is allowed to include and what expenses the landlord must exclude. From the tenant’s prospective, the list of expense exclusions is more important than what is includable.
Salaries, Wages & Benefits – The definition should limit these costs to on-site personnel at or below the level of the Property Manager. If personnel are shared among two or more buildings, the lease should require that the amounts included in
your building expenses be based on actual time spent on-site for your property. If the Property Manager and/or Assistant Manager spend any time prospecting for new tenants, negotiating new leases or renegotiating existing leases, that time should also be excluded. You should be paying for only that time associated with operating the building for the benefit of the tenants.
Management Office Base Rent – Some leases specify that operating expenses are to include the current prevailing market base rent for the on-site management office. The effect of this requirement is that the building tenants are leasing additional space without the specific use of that space for their business operations. In theory, any loss of rental income should be considered an owners sunk cost and not a cost to operate and maintain the building. If you can not get this kind of expense excluded, consider the following alternatives:
 | The management company must have a signed lease for their on-site office and that rents are actually paid.
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| The size of the leased area for which rent is to be included in operating expenses must be limited to that minimum square footage required solely for an on-site management office so that no space is included for a leasing staff. |
Electricity – This area of expense can get very complicated. One example of this complication is if there is a building tenant whose electric consumption exceeds what the other tenants normally use for lighting and office equipment power. If that tenant is not required to separately pay for that excess power, then the effect is that all the other tenants are going to pay a share of that tenant’s excess electric consumption. The two most likely reasons for excess electric consumption are large computer operations and concentrated high density communication equipment that consume a lot of operating power and requires supplemental cooling units for the extra heat generated by the computers and communications equipment.
If you are that tenant who is being billed for excess electric usage, you should be especially mindful of two points:
| How is my excess usage being measured? If by a separate meter, how do I assure myself that the meter is only measuring excess usage? How often is the meter’s calibration checked and who is responsible? Does the meter measure both kilowatt-hour consumption and demand? If a meter is not used, how is excess consumption determined? Have you had an electrical engineer review the Landlord’s methodology for accuracy?
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| How is my excess electric usage priced for the determination of my cost. Does the lease allow the landlord to use utility rates that you would pay if you had your own direct connection with the local utility company or is the landlord only allowed to charge you at the rates he is actually paying? If the landlord is allowed to use the former method, then the landlord is making a profit from your excess electric usage because you are not getting the benefit of his lower rates for the greater building electric consumption. |
If you are located in a building where the total premise electric consumption in your leased space is separately metered, and billed each month, you must ensure that, in your case, the total electric expense reported in the annual building operating expenses only reflects the common area electric. If not, then you will be paying a share of other tenant electric consumption.
One other concern with electric expenses is how the landlord bills for after-hours services; especially for additional cooling and heating. If the lease does not specify that the rates per hour charged by the landlord must be based on the landlord’s additional out-of-pocket costs, than the landlord build in a profit component within the hourly rate.
Janitorial – This is another area that can be very complicated. Just as in the area of electric costs, certain building tenants may require cleaning services in excess of the building standards being provided by the landlord’s contractor, or employees. For example, companies doing business in the global economy may have extended operating hours due to the differing time zones where they are competing. Therefore, the additional costs incurred to provide those above standard cleaning services must not be included in the annual operating expenses for pass-through to all the tenants.
One recent new area of concern with cleaning costs relates to high technology communication companies that utilize a majority of their building space for communication nodes and switching equipment. In those instances, the high technology company typically does not allow the landlord’s janitorial vendor access to the space occupied by the node and switching equipment due their inexperience in such high technology areas. If this situation sounds familiar and you currently have an operating expense base year that preceded your occupancy date, then you should request some sort of rent credit because the landlord’s total cleaning costs are now less than the base year cleaning because the vendor is actually cleaning less space because you are having a special cleaning contractor clean the node and switching equipment.
We will continue reviewing other operating cost specifics in latter article.
Stan Mullin, SIOR, is a Senior Vice President in the Newport Beach office of Grubb & Ellis and specializes in corporate real estate matters. You can learn more about his firm by looking up www.grubb-ellis.com and he can be reached at
stan@mcareceiverships.com.
Donald B. Gladkowski, CPA is Vice President, Real Estate Audit Services for Casey & Associates/ONCOR International in Baltimore, Maryland. He specializes in providing lease-auditing services to tenants throughout North America. A long-time member of the International Association of Corporate Real Estate Executives, he currently serves as the Treasurer of the Baltimore/Washington chapter. You can learn more about his firm at www.caseyoncor.com and he can be reached at
dg@caseyoncor.com. |
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