Friday, March 5, 2021

Reconciling Operating Expenses

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Today, we venture into the weeds to discuss an event that occurs this time of year. Nope. Not Chinese New Year - which is cool, by the way. But, that of reconciling operating expenses including common area maintenance charges. Fun stuff - huh? Generally, this proceeds with occupants of commercial real estate who do not own their building. In other words, tenants. You see lessees have contracts with landlords - also known as leases, rental agreements, or the like. Contained within each understanding is an outline of such things as base rent, commencement, expiration, rental increases, and responsibility for mowing the grass and fixing a leaky roof. It’s VERY important you - or someone within your group - understand how each of these cost categories is handled.
Typically, leases call for you - as the resident - to pay for expenses related to the operation of your address. If your company occupies a suite of offices - most likely you executed a Full Service Gross lease. Similar to other Gross Leases, a FSG lease lays out a rate inclusive of rent, property taxes, insurance for the premises, and general exterior maintenance. Unique to this arrangement is a charge for utilities and janitorial services which are baked into the monthly check you write. If you consider a high rise building with many enterprises - there is a prorata sharing of electricity, water, trash, and the crew that vacuums your conference room in your absence. It would be impractical to contract separately for these services - so owners don’t. Most, however, include an Expense Stop. Simply, anything above is billed to you. Below, base tent takes care of it. More on this in a moment.
Industrial landlords take a slightly different approach to re-capture costs. As an occupant of a manufacturing, warehouse, or service building - your lease probably is a TRIPLE Net Lease or an INDUSTRIAL Gross Lease. The main difference here? Rent with a NNN Lease excludes operating expenses with your monthly payment whereas an Industrial Gross Lease lumps them together. Am I saying no expenses are passed along in a NNN arrangement? Quite the contrary. They are invoiced as they occur or annualized and collected monthly.
So with that preamble - let’s get to the meat, shall we?
Each year between October and December, owners of commercial real estate budget for the following year. Taken into account are such line items as rent, property taxes, insurance, and yes - common area expenses like parking lot sweeping, trash collection, landscape maintenance, and system repairs. Considered? Is a vacancy anticipated? Are lease term extensions expected? Reviewed is how the current year fared. Were expenses properly predicted or dramatically overstated? Next, will the gardener charge us more next year? Have insurance coverages been impacted by a hurricane in South Texas? We know property taxes will increase by 2% unless a change of ownership occurred. Once calculated - a projection of next year’s - starting in January - plus budgeted expenses is forwarded.
You may be wondering - what happens if the principal collected too much money this year? Ahhh. That is where the February reconciliation begins. Akin to sending Uncle Sam too many tax dollars in anticipation of a refund - an accounting of charges collected vs realized is accomplished. If you paid too much - expect a bonus from your landlord. Conversely, an underpayment will foster a note that you owe more. Please understand. You have full rights to request backup information on anything for which your owner seeks payment. Typical would be a request for documentation outlining why a winds in Texas would affect a California insurance premium. Or why did trimming the trees cost so much.
Finally, the “more on this in a moment” promise. Delve into the terms - Base Year and Expense Stops which Full Service Gross and Industrial Gross leases highlight. Simply, these clauses limit the amount of common area expenses an owner can recover.
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at or 714.564.7104. His website is

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