Negotiating Operating Expenses

Operating expenses can be a heavily negotiated provision in a lease. Landlords want to be sure that all expenses associated with the operation of the property are included, and tenants don’t want to be charged for unreasonable expenses. A landlord’s lease form typically contains a non-exhaustive list of expenses, and a tenant generally tries to narrow that list and include its own list of exclusions.

Because the list of items which may be included in operating expenses can be so lengthy, tenants are typically concerned about overbilling. For this reason, many tenants will request a right to review the landlord’s books and records to confirm that they have been treated fairly. They will also require a provision in the lease that if they have been overbilled by a certain percentage, the landlord will pay the tenant’s costs for review of landlord’s books. Landlords will often agree to a provision such as this, but they will require that any party retained by the tenant to perform the review be compensated on an hourly basis rather than based on a contingency. By removing the contingency fee, the reviewer has no financial incentive to find overcharges and should merely review the books and records over a reasonable period of time.

One option for providing tenants with some comfort is for the landlord to provide a cap on increases to certain items. When landlords agree to a cap, they will generally carve out uncontrollable expenses (e.g., taxes, security, insurance and utilities) from the limitation. Since these amounts can make up a significant portion of operating expenses, tenants are still at risk for an unexpected bill.

To provide tenants further predictability while also avoiding both the argument over what items should be included in operating expenses and the expense of the review of books and records, some landlords and tenants are agreeing to a fixed amount for operating expenses that increases annually based on an agreed-upon factor. The fixed amount tends to build in a bit of protection for the landlord, but in return the tenant is able to budget for the annual amount without fear of an unexpected increase. If the tenant is willing to pay a higher amount for that predictability and the landlord is willing to assume a certain amount of risk that costs will not increase over the fixed amount, the parties can avoid a lengthy negotiation of the operating expense provision in the lease and the unknown results of a record review.

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