Friday, February 17, 2017

Hidden Costs in a Commercial Real Estate Lease

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That commercial building you just leased has some hidden costs that make sneak up and bite you - akin to a rattlesnake lurking in the bushes.

The bite may not be as painful as a snakes but certainly more wallet draining.

So what are these costs and more importantly how can you limit the costs in your next commercial real estate lease.

Let's dive in, shall we?

Type of lease. Take a look at the lease you signed. Across the top should be a reference to the type of lease - generally Net, Triple Net, Gross, Full Service Gross. Each has a unique mechanism for handling expenses and who is responsible. By the way, these expenses are in addition to your base rent. As an example in most NNN leases, you, as the occupant, are responsible for all the costs in addition to your base rent. In a gross lease, the landlord typically maintains, repairs, and replaces the roof - but most other expenses are yours - they just inflate your base rent.

Base rent increases. The base rent you negotiated generally is only for the first year. Typically, in succeeding years your rent will be increased by some escalator. These days we see 3-4% annual increases in the base rent. When times aren't as robust, owners are willing to negotiate a base rent that doesn't tick up throughout the term.

Abated rent. If you were successful in convincing your landlord to concede some months of base rent as an incentive for your tenancy, good for you! Just know if should fail to fulfill your obligation for the full term, you may be liable for repayment of the abated rent. As an occupant, changing the word "abated" to "free" may limit your repayment exposure.

Operating expenses. Property taxes, insurance on the building, maintenance of the foundation, roof, and walls fall into the category of operating expenses. As the tenant, you are responsible for paying these expenses - in addition to your base rent - when they are due or reimbursing the owner for these expenses. Some owners prefer to estimate these expenses for the upcoming year and then bill you monthly for the costs. Great. However, if the owner over estimates the costs, you've a refund coming. The opposite is true if he mis-calcs the other way - you owe. Be aware, these expenses increase over the term of your lease. Owners typically are afforded the right to annually "pass through" these increases to you . A major one to avoid is the increase in property taxes as the result of a sale.

Common area maintenance. Sometimes referred to as C.A.M. charges, these nasty little costs are for mowing the grass, watering the bushes, trimming the trees, sweeping the parking lot, emptying the trash bin and powering the lights outside. If you lease a location within a business park with multiple tenants, plan on this charge adding several hundred dollars a month to your rent.

Repairs and maintenance. The heating, air conditioning, warehouse sprinkler system, plumbing, and roof (if a NNN lease) are all yours to maintain and repair. So what happens if one of these systems needs a full replacement? That can be significant bucks! Generally, the owner must replace it if the cost to repair it exceeds a certain percentage. However, the owner may bill you for the replacement over a period of years.

Liability insurance. The cost of insuring the building against fire and destruction is billed to you as the tenant. You must also carry a level of liability, contents, and loss of rent coverage.

Avoid these expenses. Unfortunately, I'm not privy to a way to completely avoid the expenses - however, you can be aware they exist and put safeguards in your lease to limit your exposure. One suggestion - ask that your C.A.M. charges be capped at a certain annual increase. Another suggestion - negotiate property tax increases, in the event of a sale, be limited to a certain percentage. Finally, before you sign the lease, ask for a complete accounting of ALL the expenses in addition to your base rent.

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