What are Commercial Real Estate Lease Operating Expenses?

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When leasing commercial real estate it’s important to understand what is being included in the rental rate and what all you are paying for. Most commercial leases are going to be triple net leases where you pay your pro rata share of operating expenses as well as the base rental rate.

In many cases such as when renting commercial real estate in Austin Tx the operating expenses are going to be about half of what your base rental rate is. For example in Northwest Austin class A office space base rates are $30 sf and the operating expenses are estimated at $16 sf. In downtown Austin operating expenses are over $20 sf. As you can see operating expenses are a significant portion of your total rent amount.

Below you will learn what operating expenses are, what’s included, and what can be negotiated.

Definition of Commercial Property Operating Expenses

The definition of commercial property operating expenses (OPEX) is the costs associated with maintaining and operating a commercial property such as office space, retail space, and warehouse space. Depending on the building lease structure the operating expenses maybe a component of the gross rent or be in addition to the base rent. Most commercial office leases in Austin are going to be triple net (NNN) leases in which the OPEX are paid by the tenant in addition to the base rent. With multi-tenant buildings each tenant is responsible for their share of opex which depends on the rentable square footage of their space compared to the total rentable square footage of the building.

What do Operating Expenses Include?

• Property Taxes – The city is going to charge the property owner property taxes which are in turn passed along to the tenants. Taxes will typically be the largest portion of Opex.
• Insurance – All commercial property owners need insurance as required by the lender.
• Common Area Maintenance Charges (CAM) – such as maintenance & repairs, administrative fees, utilities, parking lot maintenance, management salaries, property lighting, etc. What is included varies by property type and building owner.

What is Not Included In Operating Expenses?

The short answer is they do not typically include capital expenses, debt service, commercial property marketing costs, leasing commissions, tenant improvement allowances, or capital reserves for future repairs.

Is Commercial Real Estate OPEX Negotiable?

If you are a larger tenant then landlords may be negotiable on their controllable items such as CAM charges since they can control how the building is managed. For example getting the landlord to agree to capping the annual opex increases. Landlord’s have no control over property tax increases, therefore will not agree to cap those.

How to Negotiate an Operating Expense Cap

• Year to Year (aka Non Cumulative Cap) – Cap the CAM percent that the landlord can increase year over year. For example with a 3% year to year cap the maximum increase the tenant is responsible for is 3%, even if it increases to 4% the 1st year.  If CAM’s increase by 2% then tenant only responsible for 2%. Most tenants prefer this approach
• Cumulative Compounding Cap – Again an annual maximum Cap is set however landlord can recoup previous years unused increases. For example  if CAM increases by 2% year 1, tenant pays 2%. Year 2 CAM increases by 4% and tenant is responsible for paying the 4% (3% for this year and 1% left from year before). Landlords prefer this method.

Examples of Commercial Property Operating Expenses

I pulled the info below from one of the commercial leases I was reviewing. Most have this sort of language in the lease that defines what operating expenses are AND what they are not.

Operating Expenses May Include the Following:

1. Costs incurred by Landlord or Landlord’s agents and contractors in connection with the provision of services pursuant to Section 7 of the Lease (but excluding the cost of utilities consumed in the Premises and the premises of other Occupants of the Building and Project to the extent Tenant or any other Occupant is separately paying for the cost of utilities);
2. Costs incurred by Landlord or Landlord’s agents and contractors in connection with maintaining the Project in accordance with Section 9.3 of the Lease;
3. Professional building management fees and the fair rental value of any management office space in the Project;
4. Costs of capital improvements, structural repairs and replacements to the Project (collectively, the “Permitted Capital Improvements”): (i) that are intended to reduce (or avoid increases in) Operating Expenses, (ii) that are required by a governmental authority subsequent to the Commencement Date (except for capital repairs, replacements or other improvements to fix an existing condition before to the Commencement Date which a governmental authority, if it had knowledge of such problem prior to the Commencement Date, would have required to be fixed pursuant to then-current government regulations in their form existing as of the Commencement Date and pursuant to the then-current interpretation of such governmental laws or regulations by the applicable governmental authority as of the Commencement Date), or (iii) that that are replacements, retrofits or refurbishments of nonstructural items which serve the Building and/or the Project in the whole or in part (including, without limitation, Building Systems, and items in Common Areas; provided, however, unless required by Law or in order to comply with Landlord’s repair and maintenance obligations under the Lease, in no event shall Permitted Capital Improvements include (1) purely cosmetic capital improvements to the Building or the Project or (2) the replacement of any Building Structure (other than sealants for any part of the Building’s envelope, including curtain walls and windows). Expenditures for Permitted Capital Improvements shall be amortized at a market rate of interest over the useful life of such Permitted Capital Improvement (as determined by Landlord’s accountants in accordance with GAAP);
5. Costs of supplies, including, but not limited to, the cost of all building-standard lighting as the same may be required from time to time;
6. Costs incurred in connection with obtaining and providing energy for the Project, including but not limited to costs of propane, butane, natural gas, steam, electricity, solar energy and fuel oils, coal or any other energy sources;
7. Costs of water and sanitary and storm drainage services;
8. Costs of janitorial and security services;
9. Costs of general maintenance and repairs, including costs under HVAC and other mechanical maintenance contracts; and repairs and replacements of equipment used in connection with such maintenance and repair work;
10. Costs of maintenance and replacement of landscaping; and costs of maintenance of parking areas (including, without limitation, the Project’s parking facilities) and other Common Areas;
11. Insurance premiums and deductibles, including fire and Special Form coverage, together with loss of rent endorsement; public liability insurance; and any other insurance carried by Landlord on the Project or any component parts thereof (all of such insurance shall be in such amounts as may be required by any Superior Rights Holder or as Landlord may reasonably determine);
12. Labor costs, including wages and other payments, costs to Landlord of worker’s compensation and disability insurance, payroll taxes, welfare fringe benefits and all legal fees and other costs or expenses incurred in resolving any labor disputes;
13. Reasonable legal, accounting, inspection, and other consultation fees (including, without limitation, fees charged by consultants retained by Landlord for services that are designed to produce a reduction in Operating Expenses or to reasonably improve the operation, maintenance or state of repair of the Project) incurred in the ordinary course of operating the Project;
14. Costs incurred by Landlord or Landlord’s accountants in engaging experts or other consultants to assist them in making the computations required pursuant to the Lease;
15. Costs of subsidized food service that is made available to all Occupants;
16. Costs necessary to comply with any REAs or any ground or underlying lease of all or any portion of the Land;
17. Seasonal and holidays displays; and
18. Events, parties and celebrations that are available to all Occupants.

Operating Expenses Do Not Include the Following

In no event shall Operating Expenses include any of the following (collectively, “Exclusions”):

1. Costs of repair or other work caused by windstorm, fire or other insured casualty to the extent of insurance proceeds received;
2. Costs of repairs or renovation necessitated by condemnation to the extent of any award received;
3. Any interest or principal on borrowed money or debt amortization, except for Permitted Capital Improvements;
4. Depreciation on the Project;
5. Any costs incurred by Landlord associated with payment of damages as a result of any breach of this Lease by Landlord;
6. Landlord’s payment of damages for personal injury resulting from the negligence or willful acts of Landlord’s Responsible Parties;
7. Costs and fees associated with the sale or refinancing of the Project or any associated debt;
8. Penalties for Landlord’s failure to pay taxes, assessments, debt services or any other charge, unless such failure arises from Tenant’s breach of the Lease;
9. Costs for which Landlord is reimbursed (other than Operating Expenses paid by Tenant);
10. All costs associated with the operation of the business of the entity which constitutes “Landlord” (as distinguished from the costs of Project operations) including, but not limited to, Landlord’s general corporate overhead and general administrative expenses;
11. The cost of services provided by any affiliates of Landlord to the extent such costs exceed the costs of such services rendered by unaffiliated parties on a competitive basis for Comparable Buildings;
12. Costs of installing any specialty service, such as an observatory, broadcasting facility, luncheon club, or athletic or recreational club;
13. Costs (other than maintenance costs) of any art work (such as sculptures or paintings) used to decorate the Building;
14. Interest and penalties due to late payment of any amounts owed by Landlord, except such as may be incurred as a result of Tenant’s failure to timely pay its portion of such amounts or as a result of Landlord’s contesting such amounts in good faith;
15. Costs arising from Landlord’s charitable or political contributions;
16. Rental loss, bad debt or capital expenditure reserve accounts (other than escrow accounts for the payment of property taxes and insurance premiums);
17. Promotional gifts; entertainment, dining or travel expenses;
18. Salaries, wages and benefits of personnel above the grade of property manager (unless equitably allocated); or
19. Reserves for bad debts or for future improvements, repairs, additions or otherwise.
20. Costs, including marketing costs, space planners’ fees, legal fees, advertising and promotional expenses, and brokerage fees incurred in connection with the original construction or development, or original or future leasing of the Project, and costs, including inspection costs and permit, license, incurred due to the installation of new tenants improvements in the Project after the Commencement Date or otherwise painting, decorating, improving or redecorating vacant space for tenants (excluding, however, common area costs of the Project or parking areas);
21. Costs or amounts paid as ground rental for the Project by the Landlord;
22. Costs to the extent arising from the gross negligence or willful misconduct of Landlord or its agents, employees, vendors, contractors, or providers of materials or services; or
23. Costs incurred to comply with Laws to remedy a condition existing prior to the Commencement Date (including, the removal of hazardous materials in existence in the Building or on the Project prior to the Commencement Date).

 

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