By John Beck, Esq.
Controlling Costs starts with the RFP
Earlier this year, we were asked to prepare a training session for a client’s transactions team. There are so many moving pieces in your leases today, that as a lease negotiator, it can be hard to stay on top of every nuance in every lease provision.
At Chelepis, we believe that tightening up your operating expense provisions from the outset of lease negotiations, beginning with your Request for Proposal (RFP), is the best method for controlling future occupancy costs.
Therefore, we give you the following HOT TOPICS for operating expense negotiations:
1. Overtime Heating, Ventilation, and Air Conditioning (OT HVAC) must be billed at actual, out of pocket cost without markup
Your first thought may be, “Overtime HVAC is not an operating expense under our leases.” To which we would generally agree with you, and we don’t advise that you define it as an operating expense (OPEX). However, we’ve recognized OT HVAC to be one of the most overlooked components of additional rent, and when it is overlooked (i.e. the landlord is allowed to set an “arbitrary” rate per hour) OT HVAC can become one of the costliest pieces of your additional rent.
When you know that your employees will be working beyond standard building operating hours, push for OT HVAC to be billed at actual, out of pocket costs. Take it a step further and request that the landlord provide a current hourly rate certified by a professional engineer. Have your engineer or Chelepis review it too!
Practice note: Generally, rates over $25 per hour per floor should prompt a review.
2. Above Building Standard (ABS) Services must be billed at actual, out of pocket cost without markup
Similar to the challenge above, you should request that billing for any ABS services will be billed at “actual, out of pocket cost without markup”. Again, we recognize that ABS services are not typically included in the OPEX provision, but we so commonly see markups, admin fees, or other fees added to ABS charges that we must include this at #2 on our Hot Topics list.
Consider this: if your landlord is billing you hourly charges for ABS Services, and billing you directly for it, are they backing out the associated payroll from building’s operating expenses? This finding may not be discoverable until you execute a lease audit. Your lease language should make it clear that all ABS costs are excluded from OPEX.
3. Gross up components are fixed, semi-variable, or directly variable
Another topic that makes our list on an annual basis: gross ups. This complex area of operating expenses can make seasoned negotiators heads spin. We’ll keep it simple, if you are allowing your landlord to gross up expenses, insist that operating expenses are classified into one of the following three categories:
Fixed (e.g. real estate taxes, parking lot lighting, landscaping, etc.)
Semi-variable (e.g. utilities, HVAC repairs, cleaning, etc.)
Variable (e.g. trash and management fees)
4. Limit allowable capital expenditures to two types
Another perennial favorite to make this list: capital expenditures. As a lease negotiator, you should start from the position that you will reimburse the landlord for only two types of capital expenditures:
Required by law
Documented energy savings
Even if you are negotiating a “pure net lease”, there is rarely a sound fiscal reason why you should be reimbursing your landlord for capital improvements or replacements that don’t fit one of those two exceptions. For capital repairs, you may give a little more leeway. If you must include capital expenditures as part of the operating expenses in a gross lease, push to make sure that capital expenditures are properly amortized and included in the base year.
5. Allow tenant to inspect sub-meters; require detailed billing
If you are going to sub-meter your electricity usage, this much should be clear: sub-metered electricity charges should not appear in the operating expenses. Additionally, you, as tenant, should have the ability to inspect sub-meters. Bring your engineer (or Chelepis) for inspection! If your landlord is going to bill sub-metered electricity, push for detailed billing that includes, at a minimum: 1) equipment Kilowatt hours (KWhs) and 2) electricity rates ($ per KHh). As with the topics above, push to exclude or limit mark-ups, admin fees, or other fees.
Our training session was originally slated to cover Operating Expense Topics for Negotiators, but, as you have read, we wanted to draw your attention to topics that are not normally defined as “Operating Expenses”. We think this reflects the industry trend of landlords removing costs from the operating expenses and directly billing tenants for such charges. In theory, direct billing can make sense and can be efficient. In practice, we find that it can lead to new profit centers for building owners. At Chelepis, we keep an eye on these trends because they impact the corporate tenant’s occupancy costs. Our expertise comes from understanding the detail behind the statements.
Stay tuned for Part 2 of 2019 Operating Expense Topics for Tenant Lease Negotiators
As always, contact us if you wish to learn more about any of these topics, or if you’re
interested in scheduling our training presentation for your transactions team.
Our success is based on knowledge of how each occupancy dollar is consumed, calculated, and billed. We offer more than the big accounting firms. We offer real estate industry experience from an operations, accounting, and engineering viewpoint; proven experience not offered by any other firm in the industry.
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