Sell for More Trivia is a weekly blog series that playfully presents a trivia question about commercial real estate.
Operating Expenses are loosely defined as the costs of maintaining a commercial property.
Leases vary greatly but the two most widely used leases are Net and Gross. With a net lease your base rent is “net” of the operating expenses. With a gross lease your base rent includes operating expenses.
So for those tenants required to pay operating expenses…which expenses are usually included in the calculation?
Property taxes are the big one. Next comes the landlord’s property insurance. This is different from the liability policies that most tenants are required to carry directly.
Last comes the group of expenses called common area maintenance. This is a broad category of expenses which can include mowing the grass, trimming the trees, sweeping the parking lot, disposing of the trash, exterior lights, property management and changing the air conditioner filters. Even reserves for future capital expenditures like a roof replacement can be included if the lease permits it.
Treatment of these common area maintenance expenses, more commonly know as CAM’s, vary widely among owners and leases. Some landlords estimate these annual expenses and require each tenant to make a monthly payment based on that estimate. Others may not bill tenants until the expense comes due.
A good rule of thumb is…the more sophisticated the landlord, the more expenses that will get passed onto the tenant. Sophisticated landlords want net leases, less sophisticated landlords are more likely to sign gross leases.
But what happens if a HVAC unit fails and must be replaced? Can the replacement cost be passed onto the tenant? Is that maintenance or a capital expenditure? Uncle Sam certainly sees the new HVAC unit as a capital expenditure that must be depreciated – not expensed. Nevertheless, many landlords will try to pass this cost onto their tenants. Most commonly, lease language allows the owner to bill the tenant for portion of these expenses spread over time – but not a lump sum. Always read this lease language carefully.
Expenses related to accounting, mortgage interest, entity fees and business licenses generally should not be passed onto tenants.
If an ownership change occurred recently, the property taxes will probably increase based upon the sales price. The tenant will usually pay this increased cost.
Watch out for generalized expenses. Most leases allow tenants to reasonably audit the expense calculation. It’s prudent for tenants to ask for back up.
Tenants shouldn’t assume there are generally accepted rules that all landlords must play by. The landlord-tenant relationship is defined by the lease, that’s it. All wise tenants should have a copy of their lease handy that’s earmarked, highlighted and has notes in the margin. This document is that important.
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About Beau Beach, CCIM
Beau is a tenacious Commercial Real Estate Broker, author and adoring father of four. His clients appreciate his no-nonsense demeanor and his legendary work ethic.
Beau leads Beachwood which is a commercial real estate broker for sellers in the Nashville, Milwaukee, South Florida and Chicago markets.
He’s the author of the books The 3 Reasons: Why Most Commercial Properties Don’t Sell and True Wealth: What Every Seller Should Know About 1031 Exchanges.
Beau can be reached at 414.324.4938, 615.603.9770, click to schedule a call or Beau@ProwessIRES.com