An Introduction to Operating Expenses in Commercial Leases By Scott W. Fielding and Travis A. Beaton
A
t their most fundamental level, lease agreements are often described as contracts or conveyances by which a landlord allows premises to be used and occupied, in exchange for a rental payment. Such general descriptions—although entirely accurate—oversimplify the complexity of leasing arrangements by suggesting that base rent alone is adequate consideration for the tenant’s use of the premises. In reality, base rent might be more precisely characterized as the base or floor monetary amount that the landlord will agree to receive in return for a tenant’s mere possession of the premises. Tenants, however, require more than just bare (ground) space or floor area and usually demand premises that are operationally equipped for tenant’s intended use, legally compliant, properly protected and insured against damages (both physical and monetary), readily serviceable, potentially profitable (if applicable), and
Scott W. Fielding is a partner at the law firm of Sherrard Roe Voigt & Harbison, PLC, in Nashville, Tennessee. Travis A. Beaton is a partner at Sher Garner Cahill Richter Klein & Hilbert, LLC, in New Orleans, Louisiana, and serves as chair of the ABA RPTE leasing group’s Retail Leasing Committee and as an associate articles editor of Probate & Property.
easily accessible, among other qualities. Although functionality is an essential component of any premises, it is usually secured by the payment of operating expenses (sometimes referred to in this article as Opex charges) that are calculated in accordance with their own lease provisions, rather than those addressing base rent. This structure is typical of the vast majority of commercial leases primarily because such expenses (most commonly including costs of insurance, taxes, utilities, and maintenance broadly defined) are difficult to estimate accurately over a lease term, rendering their incorporation into base rent (or an escalation thereof) unfeasible and risky. Still, tenants require that their premises be connected to working utilities, insured against casualties and current on property taxes, and adequately maintained for their operations; and they are usually amenable to paying their share of such expenses to their landlords to ensure the same. Consequently, leases often include provisions to pass along such expenses to tenants by imposing separately calculable Opex charges. These provisions are important, and they are often an insufficiently-reviewed part of a lease negotiation. This article will introduce the fundamental concepts governing the inclusion of Opex charges, examine their typical allocations and structure, distinguish among categories of Opex charges that are customarily included or excluded in rental
payments, and offer advice and practice tips for tenants (and their counsel) to consider in unique scenarios. Operating Expenses—Preliminary Concepts Almost all types of retail, office, or general commercial real estate leases include various forms of additional rent that are payable by tenants in addition to base rent, fixed rent, psf rent, or annual minimum rent (for purposes of this article, Fixed Rent). Additional rent almost always includes Opex charges, which at a minimum include those imposed in connection with (i) real estate taxes, (ii) insurance expenses, and (iii) maintenance costs (as used in this article, the primary Opex categories). Utility-related charges also sometimes constitute a quasi-primary fourth category, but many times are incorporated into maintenance costs. The manner by and extent to which these Opex charges are imposed upon (or passed-through to) tenants are governed by the respective lease structure (as discussed below), but among them, maintenance is the category that is least consistently defined, calculated, and collected in leases. For example, maintenance costs could include costs for utilities, janitorial services, separate HVAC, snow removal, security, landscaping, promotional or advertising costs, fire protection, compliance with sustainability standards, and trash removal, among other items.
Published in Probate & Property, Volume 38, No 1 © 2024 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
32
January/February 2024
