Operating Expense Pass Throughs – That Time Of Year Again!

A brightly colored illustration of a cozy office space.

It’s the time of the year again when Tenants receive their Reconciliation for the past year and Estimate Statements for the current year for the operational costs for their office building from their Landlords.

Office leases are generally structured as a Full-Service Gross (FSG) lease or a Modified Gross lease (MG) that allow for Landlords to “pass-through” the increase in costs of operating their office building over the first-year’s operating expenses, which is included in the rental rate for year one of a lease.

These first-year costs are known as “Base Year” costs and all future operational costs are compared against these Base Year costs. It is essential that Tenants request and receive their Base Year cost statements to be able to compare future billing the Landlord will set forth.

Each year of the lease, the Landlord will be set forth a summary of costs for the past year and an estimate of costs for the current year, known as the Reconciliation and Estimate statement.

In the ideal world, the Landlord has budgeted correctly and no funds would be due for the past year of operating the building.  Unfortunately, this rarely occurs and typically Tenants receive an invoice in March with an amount due for the past year. The statement will also have an estimate of cost over the Base Year amount which you the Tenant are required to pay monthly.  To compound the situation, as statements are issued in March, there is typically three months of estimates for the current year, known as “catch-up” that also need to be paid upon presentation of the statement by the Landlord.

Upon receipt of the Reconciliations and Estimate statements it is essential that Tenants review and compare the cost against their previously received Base Year cost to insure the billing is accurate.  Keep in mind leases typically provide a 30 to 60-day window to review the pass-through costs the landlord or property manager is asking you to pay.

The provisions in leases that provides the Landlord the opportunity to pass through operational cost is the Operating Expenses Pass Through (OPEX) and Common Area Maintenance (CAM) provisions of lease.  Operating Expenses Pass Through and Common Area maintenance costs are based upon Tenants pro-rata share space occupied in a the building.

Are the expenses outlined in your commercial lease appropriate?

Let’s start with a refresher on what Operating Expense Pass Throughs (OPEX) and CAM expenses are:

Operating Expenses is really the general, catch-all phrase used in commercial leases that encompasses all operating costs associated with repairing, maintaining, and operating a building, including Common Area Maintenance, known as CAM expenses, property taxes, insurance, utilities, management fees and administrative fees.

CAM expenses are a subcategory of pass through expenses that include the repair, maintenance, and operation of common areas, i.e. areas of a building used by all tenants, including corridors and lobbies, elevators, parking lots, and landscaping.

These costs can be limited when negotiating a lease – don’t leave dollars on the table.

Because the cost to operate a commercial building generally varies from year to year given changing tax codes, other laws, and economic circumstances, pass through expenses need detailed attention when negotiating a lease. Tenants would be wise to take a close look at the landlord’s expense provisions to prevent the burden of unexpected and rising costs.

Don’t just accept the terms of the lease. You should demand the landlord narrows their definition of Operating Expenses as well as what constitutes common areas.

Landlords want to leave the scope of your share of operating costs as open-ended as possible and often use terms such as “including”, creating loopholes that could leave you on the hook for an infinite number of unforeseeable costs. Whenever possible, insist your landlord enumerate specific expenses, while minimizing or avoiding catch-all phrases such as “all reasonable costs”.

Common areas are often another point of contention between tenants and their landlords. While it is reasonable to expect tenants to pay their fair share for the maintenance and repair of common areas (after all, the appearance and utility of the grounds and building are important to attract and accommodate customers), CAM expenses should exclude the roof, exterior walls, and foundation as well as spaces that do not benefit all tenants.

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