If your business leases space as a tenant in a shopping center, office building or industrial warehouse, the landlord's costs of operating the center, building or warehouse are likely passed through to your company. In other words, you probably pay both base rent and operating expenses. The operating expenses include costs that cannot be controlled by the landlord, such as taxes and insurance, and costs that can be controlled by the landlord, such as the cost of the landlord's employees. Oftentimes tenants, especially tenants that are represented by an attorney, negotiate an operating expense cap, in which case, the increases in operating expenses under the lease would be capped at, for example, 10% per year.
Whether you are a landlord or a tenant, the negotiation of an operating expense cap can be extremely complex, and we highly recommend the use of sophisticated counsel in connection therewith. There are many working parts in a well-drafted expense cap equation. For example,
1. The landlord cannot practically agree to place a cap on expenses that are wholly outside of its control, such as taxes and insurance. This often results in application of the agreed cap to "controllable" expenses only. It is imperative that the scope of the term "controllable" is clearly established in the lease.
2. Without well-thought-out language, the mathematics underlying the cap is often unclear. For example, assuming operating expenses of $1,000 in year 1, what result does a cap of 10% per year have in year 3 - $1,200 (a $100 increase each year) or $1,210 (the $1,100 cap of year 2 times 10%)? This will matter more in years 5, 6, etc.
3. The amount of the cap can typically range from 3% to 15%, depending on the landlord, the local market, the type of lease, etc. Place your trust in counsel having experience with those factors.
4. The lease often contains a "gross-up" provision, which allows the landlord to increase the operating expenses to a hypothetical amount that would have been incurred by the landlord assuming full occupancy. While this is a legitimate requirement by the landlord, there are pitfalls to the tenant if such a provision is not drafted properly.
These issues are very important, but they are complex. Focus your energy on your particular line of business and let us handle these details, as this is our line of business.
