Insights & Articles
Attention commercial Tenants: Do you know what’s Hiding in your operating costs?
Often times certain costs are included in the tenant’s “Additional Rent” figure that the tenant is not even aware of. These costs tend to hide in the legal language of the lease agreement as the tenant’s share of the costs incurred by the landlord in operating and maintaining the property, which are commonly referred to as “Operating Costs”, “Occupancy Costs” or “Common Area Maintenance Costs”.
It is important for clients to retain the assistance of an experienced solicitor at the very outset of the negotiation of the commercial lease to ensure that they are fully aware of and agree to the operating costs charged by the landlord. Tenants and their solicitors should negotiate inclusions and seek certain exclusions from the list of costs being passed to the tenants.
There are a number of traps to watch out for and we have created a list of a few that every tenant should know about:
Most commercial leases contain very broad language to define the operating costs. For example, operating costs are commonly defined as “the total of all costs and expenses of every kind, whether indirect or direct, attributable to the ownership, maintenance, repair, replacement, operation, administration, management, supervision and operation of the property, including, without limitation…”.
Tenants should insist that the landlord include the terms “without duplication” and “without profit to the landlord” to the definition to ensure the tenant is not paying for any costs twice and that the landlord is simply being reimbursed for actual costs incurred. Tenants should also request that the landlord “act reasonably and equitably” in allocating operating costs and should delete the term “ownership” to exclude costs associated with the landlord owning the property such as original debt finance and acquisition costs.
Lack of Exclusions and Deductions
One way to ensure that certain costs will not be included is to set out a specific list of exclusions. Tenants should seek to exclude costs such as (to name a few) structural repairs and capital costs; costs as a result of inherent structural defects or weakness; costs as a result of any negligent or willful acts or omission of the landlord; ground rentals; environmental audits/clean up; depreciation and amortization or financing costs such as interest and principal amortization of debts; income tax or other taxes personal to the landlord; landlord’s promotional expenses; and indirect and overhead expenses such as fair market rent charged by the landlord for space used by it (whether on or off-site) for management and other purposes.
Tenants should also ensure that they enumerate those items to be deducted from the operating costs such as net insurance proceeds received by the landlord (to the extent that such proceeds reimburse the landlord for costs which have been charged to tenants) and net recoveries regarding warranties or guarantees relating to the construction of the building.
Proportionate Share Calculation
It is important to review how the landlord determines the tenant’s share of operating costs. Allocations should not be determined at the discretion of the landlord and tenants should delete any such language. Often the tenant’s share is determined by way of a fraction with the numerator being the rentable area of the premises and the denominator as the rentable area of the development. Tenants should pay attention to any areas the landlord wishes to exclude from the denominator of the faction as this in turn increases the tenant’s proportionate share. Tenants should also look out for landlord’s definitions that account for when the development is not fully rented. If the denominator includes only those areas rented by the landlord, then the tenant is paying additional costs to account for vacant premises.
Landlords normally charge an administration fee on all of the operating costs. In addition to negotiating a reduction in the rate charged by the landlord, tenants should attempt to exclude costs such as professional fees, structural repairs, realty taxes, insurance, depreciation, interest, and HST from the administration fee. It is surprising how many tenants fail to request exclusions from this calculation and pay an increased fee as a result.
Tenants should carefully review those costs being passed to the tenants and understand how these costs are calculated. Prudent tenants will negotiate these costs at the offer stage and specifically enumerate the costs to be excluded to ensure such costs are removed from the landlord’s standard form of lease agreement. A careful review and negotiation will result in more money in the pocket of the tenant so that the tenant may in turn put more money back into its business.