Keep Your Landlord on a Short Lease

One of the major costs of running a business is the expense of leasing office space. Many business owners and executives spend a lot of time negotiating the term and rate per square foot of the lease, but little time in analyzing or negotiating the operating clauses of the lease — such as escalation clauses, overtime service clauses, and relocation clauses. Unfortunately, these pro-landlord lease clauses can and often do, cost the tenants thousands of dollars in additional rent payments, over the term of the lease. The best time to deal with these issues is before you sign the lease. When negotiating a lease, keep in mind that there is some language in a lease that you should avoid and some you should demand.

Operating Expense Escalation Clauses

Most leases contain some form of operating expense escalation clause contained in phrases such as: “expense stops,” “gross-ups,” “cpi escalations,” and “actual expense.” These enable the landlord to recover increases in expenses to operate the building over an agreed to base year amount. For example, the tenant occupies 10 percent of the building, the tenant’s base year is 2001, and the base year operating expense escalation amount is $1,000,000. In the year 2002 the cost of operating the building increases to $1,100,000. That means the tenant will pay 10 percent of the $100,000 increase in expenses. To avoid overpaying, avoid or modify the following lease language:

Expense Stops. Many leases will state that the rent includes an expense stop of, for argument’s sake, $5 per square foot. The tenant will pay for any expenses to operate the building exceeding $5 per square foot. If it costs $7 per square foot, the tenant owes $2 per square foot. Never accept this language. The expense stop figures used by landlords are almost always too low, resulting in the tenant overpaying for escalations.

Gross-Ups. Many leases utilize the “gross-up” escalation clause which allows the landlord to adjust upward any expenses which are impacted by occupancy — such as cleaning, utilities, and management fees — to reflect the expenses which would have been incurred if the building were 95 percent or 100 percent occupied. For example, the building is 50 percent occupied and it costs $50,000 per year to clean the building. The landlord adjusts the cleaning expense upward to reflect a 100 percent occupied building, or $100,000. In effect the landlord doubles the occupancy percentage and the cleaning bill total.

Whenever the gross-up clause is used, make sure that the base year operating expense total is also grossed-up. Some landlords gross-up the subsequent operating year totals but do not gross-up the base year operating expense amounts. This results in a windfall profit to the landlord and a major overpayment by you, the tenant.

CPI Increases.

Many landlords will try to get the tenant to pay an increase in rent and or operating expenses equal to any increase in the CPI index. For example, the cpi index increases 4 percent, the rent and or operating expenses increase 4 percent. Never accept this language. The landlord is already recouping increases in expenses with the operating expense escalation clause. The CPI is just an attempt to get some extra income on the deal.

Actual Expense Escalation Clause.

This escalation clause is the most fair. You pay for increases in expenses to operate the building, but only as it effects the base building. For example, you and the landlord determine and agree to the base year operating expense amount — including utilities to run the building, air-conditioning, heating equipment, water supply, base building labor, cleaning of the building common areas, and base building maintenance and repairs. In effect, you will only pay for the increase in expenses which are directly related to your premises or to the base building. Increases in occupancy will have no effect on your operating expenses. You will only pay for increases in the base building expenses and for the utilities consumed in your premises and the cleaning of your premises. This will be a difficult clause to get, but remember, the entire lease document is subject to negotiation.

Exclusions. Make sure that you get a “list of exclusions” section in your escalation clause. Some of the expenses that should be excluded from operating expenses are: all leasing expenses, related to both new leases and renewals; all capital expenses, unless said capital expenses reduce operating expenses; all expenses for code-compliance work related to codes which are already in effect but have not yet been complied with by the landlord; all entertainment expenses; all expenses related to other tenants’ premises in the building; all landlord negligence related expenses; all interest, fines, and late payment fees incurred by the landord; all tenant improvement expenses, management fees (if the landlord/owner chooses to manage the building in-house and does not use a third party managing agent); all expenses related to other tenant services; any expenses related to or generating income for the landlord; and all landlord corporate expenses. Remember, all this is subject to negotiation and you and the landlord will have to decide what is most important.

The Right to Audit the Books.

You must always get the right to audit the landlord’s books. This will help keep the expense record straight. Make sure you have ample time to do the audit.

One other piece of advice is to make the landlord verify, in writing, the base year expense amount totals. Too low a base year amount will result in overpayments being made by you.

Ed Eriksen is with the Tenant Advocate Group and can be reached at ed@tenantadvocate.com or by calling (561) 654-8884 or (800) 699-4901.