Understanding the Operating Expense and Real Estate Tax Clause
Don’t worry if your eyes glazed over reading that title – you’re not alone. Commercial leases have never delivered riveting prose, some of the least exciting sections of the document being clauses relating to operating expenses and real estate taxes.
But please, from a commercial real estate professional who has studied hundreds of leases over many years, I beg you, the tenant: pay particular attention to these clauses, because they can either save or cost you thousands of dollars. I’ll get to the financials in a bit, but first, some background.
What is the "Operating Expense and Real Estate Tax" clause?
In short, it’s a lengthy section of the lease describing what can and cannot be passed from the landlord to the tenant as an expense. An office building or complex of any size requires expenditures by the landlord to keep the lights on and make repairs and improvements, costs that are typically passed on to the tenant.
Just how much of these costs a tenant shoulders depends on how well a tenant and its advocates negotiate.
Are operating expenses negotiable?
Absolutely! For starters, the tenant should ensure that in a gross lease – one where operating costs are included in the rent – their base year(s) are clearly defined and grossed up as if the building were 95 or 100 percent occupied. This can save you lots of money; as artificially low base years can be extremely expensive to a tenant.
Make sure your lease allows you the right to audit the expenses each year. Once base year expenses are cemented in the lease, they are often difficult to change or argue years into your lease.
Second, ensure that the definition of “operating expenses” is clearly defined. Have this section reviewed by a tenant’s advocate (like Cresa) to identify which expenses are customary for your particular market and which aren’t.
Anything else I should know?
Review and monitor the clause every year, especially when the building is under new ownership or management. A favorite hunting ground for added revenue for new owners and managers is the operating expense and tax clause.
Reviewing the clause and auditing the taxes and operating expenses annually can protect the tenant against unwarranted rent hikes. In other words, don’t just treat it like your phone bill at home and pay it automatically. Pour over it with a fine-toothed comb.
A lease can be a wonky, uninspiring document – but understanding it is vital to a commercial tenant flourishing in a space and saving capital. The Operating Expense and Real Estate Tax clause, while boring on its face, is one of the areas where tenants can lose big if it’s not taken seriously. So pay attention. This clause is important to the landlord, and it should be important to you.