Who Should Pay To Replace the HVAC, Landlord Or Tenant?

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Should a tenant be required to pay for the replacement of pieces of the real property within or serving its leased premises? We don’t know. That’s because it isn’t a legal matter. It isn’t a moral matter. It isn’t a matter of logic. It isn’t a matter of fairness. It is part of the economics of the deal, one whose answer will be determined by the negotiating process.

At the end of the day, the issue isn’t about the “money,” it is about the risk – the uncertainty. Why does Ruminations dare to say it isn’t about the money when virtually every reader has already thought: “Are you out of your mind”? That’s because the “market” needs to make a profit one way or another. To assure there is a real estate market, the aggregate tenant rent at a property needs to be sufficient to generate that profit. In the aggregate, the industry will either generate acceptable investment returns or property values will drop to a point where an investment in property will “again” generate an appropriate return.

Now, is the “crowd” of our readers wrong in thinking Ruminations is availing itself of the increasingly available recreational drug of choice? No, it isn’t, because our readers are rightly thinking about the economics of a particular landlord-property owner dealing with a particular property. At the end of the day, but for disparities in bargaining power and market knowledge, the rent for any particular deal will be what other landlords in the area are getting adjusted by factors such as better or worse locations, etc.

So, like it or not, we are going to continue as if tenants, one way or another, are going to pay for replacement of items such as their own HVAC. That allows us to explore an approach that might wind up being an acceptable compromise for the “you will pay for replacement; no we won’t” bargaining that very often takes place even between landlords and large, strong bargaining power tenants.

If there is any logic to having a tenant pay for replacement of building parts it must be that they are paying “extra” for use of those building parts and what they are using is “exhaustible.” By exhaustible, we mean they wear out by “use,” kind of like tires. There are two ways to pay for wearing out such items. One could pay a little each month specifically tagged as the cost for wearing out the HVAC equipment or the water heater or things like that. An estimate of the item’s life and replacement cost could be made and a monthly charge could be calculated. But, no one does that. Either they build the cost of replacements into the basic rent or they expect a tenant to bear the risk of both the life of each exhaustible item and the risk of the cost of those items. What is more, most of the time negotiations over a tenant’s absorbing the cost to replace building components goes something like this: “Well,” the tenant will say, “reluctantly, we’ll pay, but not if the such-and-such needs replacement in the last (fill in the blank) years of the lease.”

Is there a different, presumably better, way to allocate the replacement cost of an exhaustible item? Ruminations thinks so. It’s not an entirely original one. All right already, what is it?

Why not have the tenant pay only a prorated share of the cost of the item based on its actual cost at the time of replacement and the manufacturer’s estimated life? Add it to the rent (with interest if you like). Basically, the tenant would be renting the item based on its expected life span.

Now, this isn’t the strangest thing readers will ever see. In fact, a few readers, perhaps too few, may already be taking this kind of approach though we’ve never seen it taken – except when it comes to parking lot pavement replacement.

Now, we don’t think a tenant should be paying for these items at all even though we know, pragmatically speaking, that the “market” has a different thought about this. But, laying out our idea, explaining it as a way by which a tenant only pays for what is “uses,” allows us to explain why we don’t think a tenant should be paying at all.

Basically, tenants pay a set rent and use the building’s components such as the HVAC system that serve its space. They don’t pay extra for the system. So, why should it start paying extra if what was included in the rent in the first place needs to be replaced? Tenants don’t want HVAC systems. They want heating, ventilating, and air conditioning, not equipment. The premises were rented as heated, ventilated, and air conditioned. They wouldn’t have rented the space if that wasn’t the case. So, why should the fact that the equipment has finally huffed its guts, coincidently when they were in occupancy, cost them extra? Having said that, if that’s the deal, at least a tenant shouldn’t be paying for that part of something’s life that reaches beyond the tenant’s occupancy.

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Comments

  1. Excellent blog article – I had two such cases involving rooftop air conditioning units and in both cases I ws representing the Tenants. In one case, the Building’s owner agreed with the Tenant’s position and over ruled the Property Manager and in the second case, it is still under review / discussion between Property Manager and Tenant.

  2. Larry Ross says:

    In Ontario it is fairly common practice to include a portion of the amortized capital replacement as additional rent. For example. If HVAC has a 10year amortization then the tenant would pay a one tenth each year. . BTW some leases also charge interest at the bank prime for the unamortized portion as additional rent

  3. Peggy Israel says:

    At lot of times in retail its the flip issue — Tenant has the obligation to repair and replace the HVAC but Landlord should reimburse Tenant for the unamortized value of the amounts expended upon expiration or earlier termination. The underlying assumption in that position is that the Landlord has the obligation to provide the HVAC in the first place and requires the Tenant to leave the HVAC upon lease termination…at no point does the HVAC system actually “belong” to Tenant.

  4. Having completed over 1,000 leases on the landlord side for some sizeable companies owning millions of square feet and completing over 100 leases per year, I find it a joke that landlords think that it is fair in most circumstances to charge for HVAC repair and replacement and even maintenance unless the tenant prematurely causes it to fail from abuse or overuse.

    Landlords have gotten ridiculous with their extra charges and profit centers. I just finished a legal case as an expert witness on NNN for a large tenant and the landlord was charging a supervision fee, management fee, and an asset management fee. We won the case and my client was credited over 1 million dollars. And this has happened about 10 times in the last 2 years just on matters I was involved with.

    Landlords should put the HVAC in full into the rent and/or NNN where applicable. To have a lease set up such that the tenant has to pay for it especially after they inherited an older HVAC unit is simply unreasonable.

    Landlords already have plenty of other profit centers and this is just another one.

  5. I’ve drafted a few leases that have the tenant paying the annual amortized value of a replacement HVAC during the term. The other difficult circumstance is what happens if the unit is damaged by casualty. Typically, HVAC is not included in a causes of loss – special form policy. It must be added by endorsement or separate policy. In reality, if the Lease does not require this special insurance, it may not be insured at all. As a question of fairness, I think Landlord should carry this insurance and bill it through as CAM (but without markup of course … but we all know that there will be some administrative fee involved).

  6. This is constantly a negotiated point. I have successfully negotiated several times a formula if the HVAC needs to be replaced during the term of the lease. Take the remainder of the lease term, and divide it by the useful life expectancy. The tenant pays that portion. So, if there are 3 years remaining on the lease, and the useful life expectancy is 20 years, the tenant pays 15% of the cost. If there is a lease renewal, the additional amount gets built into the renewal. That is the fairest way to go. Too often I have had commercial tenants come to me for potential litigation complaining that their landlords are requiring a replacement at $20,000 and there is only a year left on the lease. Unfortunately, I tell them that they should have come to me to negotiate the lease in the first place.

    • Jeremy J. Deeken says:

      As a follow-up to Jonathan’s point, I think any ‘fixed’ option rate should include a caveat allowing for an adjustment if the HVAC is replaced and the cost is to be allocated as Jonathan suggests. There is also a more general argument for requiring the party who is in charge of maintaining and repairing the HVAC to also replace it- since its condition in more under that party’s control.

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