31 Items That Shouldn’t Be Found In A List Of Operating Expenses If A Tenant Is Paying The Bill

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Last week we promised a list of 30 Operating Cost carve-outs a tenant might seek. We found a 31st lying on the floor. So, in a giant departure from our usual Ruminating, save for an ending paragraph to this blog, we’ll just post that list and say nothing more than what is in this paragraph. We’re not abandoning our usual rambling approach or even taking a week off (given that we wrote this week’s post quite some time ago). It’s just that we’ve written about some of these items before and promise to write about those and many others for a long time to come. So, without further ado (other than to apologize to Shakespeare or Marlowe or Bacon or whomever), here is our list. It is aimed at an office building because that gives us the opportunity to write a longer list than that for a retail property, but it can be easily adapted to retail projects. Tell us what we’ve missed.

(a) depreciation of the property or any part thereof

(b) leasing commissions; costs, disbursements, and other expenses incurred for leasing; costs to renovate or improve space for tenants, whether such work is performed for the initial occupancy of such tenant or thereafter; any and all cash or other consideration paid by landlord on account of or with respect to the tenant work described in the foregoing clause, and in addition thereto; “takeover expenses” (i.e., expenses incurred by landlord with respect to space located in another building or expenses of any kind in connection with the leasing of space at the property)

(c) costs (including permit, license, and inspection fees) incurred in renovating, improving, decorating, painting or redecorating vacant space or space for tenants

(d) landlord’s cost of electricity or other utility services sold to tenants for which landlord is to be paid or reimbursed as a charge in addition to the rent or additional rent payable under leases with tenants

(e) costs incurred by landlord for alterations that are considered capital improvements and replacements under generally accepted accounting principles consistently applied except for annual amortization of those items expressly provided for in the lease as includable within Operating Expenses

(f) costs of a capital nature including capital improvements, capital repairs, capital equipment, and capital tools, as determined under generally accepted accounting principles consistently applied, except for annual depreciation or amortization of those items expressly provided for in the lease as includable within Operating Expenses

(g) costs incurred by landlord because a tenant violated or was alleged to have violated the terms of its lease

(h) amounts paid to subsidiaries or affiliates of landlord for management or other services on or to the property or for supplies or other materials, to the extent that the costs of the services, supplies or materials exceed the competitive costs of such services, supplies or materials were they not supplied by a subsidiary or affiliate

(i) ground rents and interest and amortization of indebtedness and any costs of financing or refinancing

(j) the cost to landlord to operate any commercial concessions at the property (including, without limitation, any cafeteria or similar operations)

(k) rentals and related expenses incurred in leasing air conditioning systems, elevators or equipment ordinarily considered being of a capital nature, except equipment used in providing janitorial services that is not affixed to the building

(l) items and services for which the tenant reimbursed landlord or pays third parties or that landlord provides selectively to one or more tenants of the property other than the tenant without reimbursement

(m) advertising and promotional expenditures or the cost of maintaining a leasing or marketing office for the property

(n) the cost of repairs or replacements incurred by reason of fire or other casualty or condemnation to the extent that: (A) landlord is compensated therefore through proceeds of insurance or condemnation awards; (B) landlord failed to obtain insurance against such fire or casualty, if insurance was available at a commercially reasonable rate against a risk of such nature at the time of same; or (C) landlord is not fully compensated therefore due to the coinsurance provisions of its insurance policies on account of landlord’s failure to obtain a sufficient amount of coverage against such risk

(o) nonrecurring costs incurred to remedy structural defects in original construction materials or installations

(p) any costs, fines or penalties incurred because landlord violated any applicable governmental requirements

(q) costs incurred to test, survey, cleanup, contain, abate, remove or otherwise remedy hazardous wastes or asbestos-containing materials on or from the property unless the wastes or asbestos-containing materials were in or on the property solely because of the tenant’s negligence or intentional acts

(r) costs incurred in connection with the sale or change or ownership of the property, including, without limitation, brokerage commissions, attorneys’ fees, closing costs, title insurance premiums, transfer taxes and interest charges

(s) costs, fines, interest, penalties, legal fees or costs of litigation incurred due to the failure to pay bills when due, unless caused solely by the tenant’s failure to pay or late payments of the tenant’s pro rata share of increases in Operating Expenses

(t) taxes on the personal property of other tenants

(u) costs incurred by landlord for trustees’ fees or partnership or corporate organizational expenses

(v) costs of utilities directly metered to tenants (including tenant) of the property and payable separately by such tenants

(w) increased insurance premiums caused by landlord’s or any tenant’s hazardous acts (other than those of tenant)

(x) costs incurred for any items to the extent covered by a manufacturer’s, materialman’s, vendor’s or contractor’s warranty (a “Warranty”) which are paid or reimbursed by such manufacturer, materialman, vendor or contractor and the costs of any items that are not covered by a Warranty but for which a reasonable, prudent landlord would have obtained a Warranty. Unless landlord determines in good faith that such action would not be in the interests of the tenants on the property, landlord shall pursue a breach of warranty claim for items covered by a Warranty, provided that the costs of pursuing such claim, including without limitation reasonable attorney’s fees, may be included in Operating Expenses

(y) fees paid for asset management services relating to the property

(z) any deposits

(aa) omitted or additional real estate taxes assessed during the Term but relating to a period prior to the Commencement Date or after the Termination Date

(bb) Federal, State or local income, revenue or excise taxes imposed on landlord or any inheritance, estate, succession, transfer, gift, capital stock, franchise, or excess profit taxes (unless imposed solely in lieu of Taxes)

(cc) landlord’s limited liability company or other entity overhead not related to management of the building

(dd) salaries or fringe benefits for other than on-site personnel and then only for the time spent on-site by such personnel

(ee) any other expenses that under generally accepted accounting principles consistently applied would not be considered normal maintenance, repair, management or operating expenses.

Here is this week’s ending paragraph. We would rather have posted a list of what CAM Costs (or Operating Expenses) should include, but that’s an approach that has never (not yet?) taken hold in our industry. And, yes, we made some choices in furnishing this list. For example, our list would have the tenant pay its share of the property insurance deductible amount. As a list of exclusions, it is, by definition, a “tenant’s list.” Even at that, we know readers (even those on the “tenant side” – that’s not us; we’re agnostic) have additional or different items for the list above. Post them to Ruminations by finding some form of the word “comment” under the title to this week’s blog posting, and clicking there.

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Comments

  1. Not sure I would necessarily argue with the contents of the list, but the best way to avoid the arguments altogether (during lease negotiation & on an ongoing basis), administrative costs for landlord, and auditing costs for Tenant is to agree to a ‘fixed CAM’ adjusted annually be CPI or pre-established percentage. Both parties can anticipate and budget accordingly. The only ones that truly lose out in this arrangement are the attorneys’ and auditors’ billable hours!!! As I’ve said in prior posts, our portfolio of over 30 million s.f. has exclusively utilized fixed CAM for nearly 50 years without issue and many REITs are now embracing this concept, too.

    • Susan Pugach says:

      Anthony,
      I would be interested to learn more about the fixed CAM that you utilize for your leases.
      Thank you,
      Susan

    • Randall Gunn says:

      Fixed CAM has advantages BUT, there needs to be an opportunity to adjust (up or down) every 3 – 5 years. The alternative is to have a fixed CAM within the base rent automatic increases. There is risk on landlord and tenant side. The shared risk makes both sides feel better.

  2. Joel Hall says:

    Anthony: As an attorney who bills by the hour, I nevertheless do not relish negotiating CAM inclusions and exclusions and prefer the fixed CAM approach. Whether one represents a landlord or a tenant, I think both parties are better served by this approach. At the conclusion of every lecture i have conducted on negotiating CAM exclusions, I end with “Now, on the other hand, we can forget everything i just talked about for the last 90 minutes and go with a fixed CAM formula.” While several of the large developers have adopted this approach (at least with their chain tenants), the negotiation of actual CAN is still with us as tenants fear they are paying too much with a fixed charge and landlords fear they are receiving too little, So, if I am asked by my client to negotiate a CAM clause, I do my best.

  3. H W Burns says:

    Elaborate on “d” to reflect that if a Tenant has its own account for a particular utility it can’t be charged CAM for the same supplied by Landlord to others: Any utilites provided to other tenants for which the Tenant has its own contract and pays directly. By way of example, all the contiguou shop tenants are provided water by the Landlord as part of CAM but the pads are all on individual meters billed directly to the pad tenants. Often true of Trash too.

  4. Add Cash Reserves for future expenses. Great list.

  5. BOMA teaches a course on this very subject of operating expenses and the course includes what should and should not be included. And even though BOMA is a landlord’s organization, this method is usually ignored by most landlords and their lease forms because landlords tend to want to make this area a profit center like so many other areas and really don’t care if it’s fair or reasonable to the tenant or not.

    I can agree with the fixed expense method but only to the extent there is full disclosure to the tenant on what the operating costs have been for the past 5 years or so historically and what they currently are so the tenant can see that the starting operating costs for the first year of the term are legit and feel comfortable having each year build on this base year. But there is a danger here in fixing this area as it reminds me of trying to fix the market rent for an option to renew 5 or 10 years into the future rather than having the then current market dictate what the rent should be at renewal time and having each party negotiate like usually happens. I have found that by fixing the rent one party doesn’t do nearly as well as the other party and I think the same will hold true of operating expenses once you try and fix them.

    And what happens when the landlord successfully appeals a big expense category like the property taxes and saves hundreds of thousands of dollars? The tenant simply loses out. Although the landlord could lose out also, my experience in this matter tells me that landlords set the expenses higher than they really are and most of the time it is the tenant that loses out on savings.

    Bottom line: After being involved in hundreds of audits for operating expenses, I still think the fairest way to agree on this matter is to be up front about the expenses and not include items that should be landlord costs like capital expenses or other costs that are unfair to tenants like high insurance deductibles (think earthquake insurance which usually has a 20% deductible of the entire project’s value and can easily equate to 4 years of rent or more for a tenant), haz maz issues not caused by tenant and/or in excess of tenant’s insurance policy if covered by tenant’s insurance, and so much more that the landlords have added to the operating expense pot that shouldn’t be there.

    What landlords fail to remember in the long run is that if they are unfair in this area, word spreads to other tenants and brokers and they lose existing tenants and new deals because of their reputation in this area.

  6. Randall Gunn says:

    There are only two items listed where I have received push-back from landlords. Unless you are at least a junior anchor, it is tough to get the landlord to give up (m) marketing expenses. Like many expenses, the anchors and junior anchors will not pay. The local tenants WILL pay the cost.. Landlords also are reluctant to give up (dd), portions of the off site salaries. Anchors can fight it. Locals can not.

  7. One of the other big issues regarding a cap on CAM is the presence or absence of a “look back” clause or cumulative cost provision whereby the Landlord is able to add back into CAM for a particular year in which the Cap has not been reached, a portion of the Cap-excluded CAM from prior years. Essentially, then, CAM expenses exceeding the Cap for each year are “deferred” not eliminated. While the bite of this provision will not be felt by a tenant in higher inflationary periods where the Cap is routinely met or exceeded, it might be quite painful to the tenant in lower inflationary periods (such as may result from a downturn in the economy when the tenant is struggling as it is) when it ends up paying the full Cap amount year after year as the deferred CAM amounts from prior years are burned off. Smaller tenants will not be able to remove that provision, but they may have some success negotiating a “cap” on the deferred CAM charges that may be added to the actual CAM charges for a particular year to avoid a big hit.

  8. This is a great list and resource!

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