What comprises your total lease obligation?

Some tenants have the misconception that after they negotiate a great lease rate, that's it.  They add up the total payments as stipulated in the lease and unfortunately assume that is the entirety of the commitment over the term of the lease.  What they do not take into account is what is referred to as "operating expenses".

There are a lot of things to consider when you are calculating how much your rent and other office occupancy expenses will actually cost. 

Base rent is the amount of money you pay to lease your space and it is specified in your lease. It is generally stated as a whole dollar amount such as $45,000 per annum or as dollars per square foot such as 1,500 square feet at a rate of $30.00 per square foot per annum or $2.50 per square foot per month.

The lease will also state if the rent is Net or Gross.  Gross Rent generally includes all the operating expenses required to run the overall building on a day to day basis.  Net rent excludes all the building operating expenses and you will be billed an additional amount monthly. This is usually based on your proportionate share of the total building operating expenses.

These definitions of "net" and "gross" vary widely, so you need to ask about what is specifically included or excluded from the rent you are quoted.

Operating expenses are all those expenses that are generally required to keep an office building running.  Operating expenses are usually divided into two components: Real Estate Taxes and Operating Expenses which includes insurance.

Taxes are the local real estate taxes, which are based on the assessed value of the building and the land on which it is situated.  In some communities these taxes can include additional taxes such as school taxes and special assessments for sewer hook-up and use.

Operating expenses include: elevators, mechanical systems, heating, ventilating and air conditioning known as "HVAC" systems, plumbing, electrical, water, gas, equipment replacement, landscaping and property management costs. The list is endless.  Unless put in check, landlords will use much freedom to charge back everything they feel should be a tenant expense.

When you sign your lease, it is imperative that you have an idea of how much it will cost during the first year of your occupancy and an understanding of how much your rent is going to escalate over the term of your lease.

Rent escalations are usually divided into three categories:

• Base Rent increases
• Increases in Additional Rent
• Escalations in operating expenses and taxes.

Base Rent increases are generally stated precisely in the lease. For instance your lease would say something like:

"The Base Rent shall be $45,000 for the first lease year, $46,350 for the second lease year and $47,740.50 for the third lease year".  Or base rent increases can be calculated by a formula. "The base rent shall increase by 3% per annum".

Additional Rent and any increases in additional rent are usually stated as a formula based on your proportionate share of the entire office building. For example, if a building is 100,000 square feet and you occupy 1,500 square feet, your proportionate share is 1.5%. That means you will pay 1.5% of the total operating and tax bill for the building as additional rent.

The language in your lease will read something like this:

"Tenant's base rent shall be $30.00 per square foot per annum, net of all expenses. Tenant shall pay on demand its pro-rata share of all operating expenses and taxes for the property as Additional Rent".

If you have a net lease the owner will total all the expenses and send you a bill for your proportionate share. Generally the owner estimates what the total expenses will be for the entire year in advance, divides it by 12 months to average it and bills you 1/12th of your proportionate share of the total building expenses as Additional Rent, which is added to your rent each month.  At the end of the year, the Landlord will review the expenses for the year and either sends you an additional bill or a refund depending if the expenses were under-estimated or over-estimated.

Here is an example:

A 100,000 square foot building paid Real Estate Taxes of $3.00 per square foot last year, or $300,000 per annum; operating expenses for the building were $7.00 per square foot, or $700,000. Therefore, the total Operating Expense and Real Estate Tax bill for the prior year was $1,000,000.  You occupy 1,500 square feet or 1.5% of the building.  Consequently, your proportionate share is $15,000 for the year or $1,000,000 X 1.5%.  If you have a net rent, your monthly Additional Rent will be $1,250.00.

If you have a Gross Lease, the cost for the operating expenses and taxes are included in the rent during the first year of your occupancy; this is also known as the "Base Year". As the buildings expenses escalate in subsequent years, you will pay your proportionate share of the increases over the Base Year, or initial year of your lease.  In other words, if the operating and tax bill for the entire building increases to $1,200,000 in the second year of your lease and it was $1,000,000 during the first year of your lease (the Base Year), your Additional Rent will be $3,000 or an increase of $250 per month.  A $200,000 increase over the base year X 1.5% divided by 12 months = $250.00.

When you are selecting your office space, you should ask for a breakdown of the operating expenses and taxes so you can estimate what your rent increases will be during the term of your lease.  Be careful to determine if the building is going through a reassessment or sale.  This could cause a dramatic increase in taxes.

Make sure you understand the services you need to run your office and understand what is included or excluded from the services your landlord will provide.

What most business owners don't realize is leases are written to provide the landlord with the ability to pass through increases in expenses with little incentive to maintain costs.

Many landlords will increase the operating expenses over the term by passing through employee costs.  This is done when landlords do not separate their general administrative employees from those employees that exclusively service the building.  This is deceptive and potentially illegal. 

Operating expense statements are typically vague and offer no real explanation as to how the landlord spent money.  Are the cost increases legitimate? Is accounting consistently applied from year to year?

The tenant or their CFO often just writes the check, as often times they don't have the time or don't know the questions to ask, or where to begin to look for inconsistencies.  Tenants blindly spend millions of dollars annually for operating expenses.  It is important to negotiate auditing rights to make sure you are being billed properly for operating expenses.

As a seasoned Tenant Rep my team has the experience to negotiate your office lease renewal or relocation properly.  My team includes two extremely talented individuals that can audit your lease to make sure you are not being overly charged for operating expenses.  In many cases they will have the landlord issue you a check for the amount overcharged.

Please contact me to discuss your office space needs.