Operating Expenses: Mind your P’s and Q’s!

Operating Expenses: Mind your P’s and Q’s! By Bill White

As we approach the end of the year, Landlords everywhere are beginning the process of preparing operating expense reconciliation statements. These statements call out the amount of the building’s operating expenses for which each tenant is responsible. As nearly 50% of a tenant’s full service gross rent is made up of operating expenses, savvy tenants will evaluate these statements carefully to ensure they are being charged correctly.

Oftentimes tenants are surprised when they receive a statement containing expense increases higher than anticipated. Despite this surprise tenants often accept the fact that costs are rising and routinely pay the increase uncontested. After all, most landlords are sophisticated operators with complex accounting systems that carefully calculate all of the expense exclusions you fought so hard for during your lease negotiation, right?

Perhaps not. The fact is that many landlords may not honor or recognize specific operating expense exclusions when they prepare their annual reconciliations. While there may be many possible reasons for this, the onus is on the tenant to ensure that all of the expense exclusions cited in it’s lease are not being passed through errantly. White Space Advisors recommends taking the following steps to ensure you are being charged correctly:

Request a detailed breakdown of expenses:  Oftentimes building owners only offer a general statement with broad categories of expenses. To effectively determine accurate pass-throughs you must have a detailed statement or “line-item” breakdown of the specific expenses within each category. If your landlord “balks” at this request, insist on it and make sure the allowable period for your review of the statements is tied to the receipt of this more detailed statement.

Compare the statement to your lease:  Standard leases contain an extensive list of items that make up the operating expenses of a building and/or project. Also listed should be items that the landlord is NOT to pass through to tenants. Despite the language contained in the lease, White Space Advisors routinely reviews statements containing errant inclusions of expenses.

Items that should be reviewed carefully are as follows:

Real Estate Taxes: Taxes make up the single largest component of a building’s operating expenses. Given the massive reduction in property values that has occurred over the past few years, make certain the correct property tax cost is being charged to you.

Salaries: Building owners may include as part of the expenses of a building the salaries paid to personnel involved in the management and maintenance of the building. As a general rule, only the salaries of staff DIRECTLY involved in the everyday management and maintenance of the building should be included. If staff members work on more than one building, their salaries should be “pro-rated” to reflect the amount of time they spend on duties in your specific building. Further, executive salaries should generally NOT be included as oftentimes the activities of such “higher-ups” are not at the “property level”.

Ground lease payments: If your building is sitting on leased land, lease payments to the landowner should have been excluded from expense increases at the time you signed your lease.

Leasing Expenses: Expenses for the marketing, advertising, and leasing of the building should not be passed through to tenants. This includes leasing commissions and legal fees paid in connection with the leasing of the premises.

Tenant Specific Charges: Charges such as after-hours air conditioning or heating, use of freight elevators, or specialized maintenance costs should not be passed through to tenants, as the Landlord should already be reimbursed by the tenant(s) utilizing theses extra services.

If you have any questions about your lease, or the current state of the commercial real estate market, please contact Bill White at White Space Advisors directly at 949-721-8880 or via email at bill@whitespaceadvisors.com.

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