The Unavoidable Issue Of Tenant Creditworthiness

Recently, I was working with a tenant whose entertainment-based business was doubling year over year.  He needed to move out of his 4,000 square foot space and find something around 12,000 square feet to facilitate contracts that were coming down the pike from major entertainment companies and studios. 

We found the perfect building in the perfect location and lobbed a reasonable offer in to the landlord.  We were making progress negotiating terms but when the landlord looked at the tenant’s financials we hit a snag; well, more than a snag – a brick wall.  The landlord was concerned over the tenant taking on rent that was triple what he was currently paying and demanded a huge security deposit to offset what he perceived as the risk in leasing his building to my client.  The up-front cash demand killed the deal. 

My client was extremely disappointed.  This is understandable but I explained to him that I have successfully navigated negotiations for tenants facing greater challenges:

  • I had a client who had a recent bankruptcy on their record that would have cut off discussions with many landlords.  I coached them to present a story that explained how their recent financial troubles were unrelated to the business that would be operating in the space and paying rent.  We got over the hump and negotiated a very fair deal for them.
  • I had just finished negotiations on a 10 year lease of a surface parking lot in an upscale Westside commercial district for a client who was an immigrant from south Asia and who had just become a citizen of the U.S.  While he had several years of experience in the parking lot management industry, he didn’t have two nickels to rub together.  We got the deal done – with a sophisticated landlord, no less – without providing any financial statements whatsoever.  The tenant did have to pay an enhanced security deposit but I negotiated terms that will get most of it refunded to him after the first couple of years of the lease.

Tenants with less than stellar financials will occasionally encounter a very skittish property owner but there are others out there that will be much more open to leasing to a promising business.  

A good tenant representation broker can help write the story that will end in “happily ever after”.    

No Need To Succumb To Unfounded Fears

Far be it for me to tell you a good real estate broker and tenant advocate can build a protective force field that will protect your business from the occasionally harsh winds of the market and the law.  But I am here to tell you that there is no need to be afraid of the monster under the bed.  There is nothing under there…really.

I had a manufacturer client that had been doing business in the same building since their inception 55 years earlier.  As a concession to getting some rent relief from the family that had owned the property since the dawn of time, they agreed to a six month cancellation clause in the event the property was sold.  It never occurred to my client that might happen…and then it did.  When they got the six month notice from the new owner they were blindsided.  That is when I was referred by their banker to help them find a new home.

The president and CFO of the company were panicked.  How could their established manufacturing company possibly find a new location and move there in six months?  Their fear was existential  -- was the company doomed?

With 25 years of property management experience , I knew how hard it is to physically pry a tenant out of a space.  Ultimately, the law will side with a landlord against a tenant that is ignoring valid demands to vacate their premises but it takes time and a lot of legal gyrations.   My message to them was to take action toward the goal of vacating the property and communicate their progress to the new owner.  Six months might turn out to be a year but if they were responding in good faith to the demand to leave, the landlord would certainly spare themselves the legal cost of being draconian.  I also reminded my client that the new owner had plenty of hurdles of their own to clear in order to make the necessary changes at the property to accommodate their business there.

My client settled into their new home across town approximately 10 months after I signed on as their broker.  They followed my advice and kept the new owner informed and in the end, the scary monster under the bed turned out to be Shrek.  OK, maybe a little ugly but docile.

Hire experience and let it be your guide.  Don’t go it alone.

Tenant Improvement or Landlord Improvement?

One of the fundamental economic facets of a commercial lease is the value of the tenant improvements that that are constructed for the new tenancy.  Whether it is an office building, shopping center or an industrial property, paying for the construction of needed improvements or upgrades is a major consideration for both the landlord and the tenant.  In the case of a tenant improvement allowance, the landlord contributes a stipulated amount and the tenant pays for any cost overruns.  A good understanding of the logic behind these improvements can go a long way toward getting a little more for the tenant.  The key is to look at the nature of the improvements.  

A Heartwarming Landlord Story

Putting “Landlord” and “Heartwarming” in the same phrase may seem farfetched to some.  The truth is, landlords’ hearts freeze over only when tenants demonstrate a lack of understanding or respect for the contract they both signed.  When a tenant shows proper respect for the contract, the landlord can be their best friend.

Deploy Your Crystal Ball For Real Estate Planning

As a professional commercial real estate broker, I have come to the heartbreaking realization that my clients just don’t think abouttheir real estate every day; indeed, they think about it only when they absolutely have to.  The problem is that real estate decisions sneak up on you and then you find yourself with limited time to make them, and limited choices.

Sometimes The Real Estate Is Only One Leg Of The Race

When you are negotiating to purchase a business part and parcel to accelerate your growth, expand your business range, or increase your market share, there are two critical facets of a sound economic deal: the valuation of the business and the cost related to the real estate. 

When the real estate is for sale with the business, establishing the intrinsic value of the real estate is more or less a function of two standard appraisal practices: analyzing value by looking at comparative sales, and by looking through the lens of the highest and best use of the property.  

It becomes a bit trickier when the real estate is retained by the seller and leased to the buyer or is leased in the first place.  The rental costs of the real estate have a huge impact on the net income projections of the business and cannot be negotiated separately from the acquisition of the business enterprise.  Doing so puts untenable pressure on the dealings for the second piece and negotiations could breakdown altogether.  The two major financial pieces must be on the table at the same time. 

I am typically involved in the buy side and recommend to my clients that they let the business seller express their preference of whether they want to get the best possible pricing on the business or on the real estate.  Then everyone involved knows what part we will be negotiating and understands how the two are linked together.

Exercise both legs simultaneously or else you will be limping – or worse, hopping – toward your future success.

Keep A Scorecard When Searching For Properties

One of the messages I always convey to new clients when embarking on a search for a new location for their business is that it is a process; that is, the search itself serves to bring into focus what is important to them and that it is OK to shift their priorities along the way.  Nothing brings must-haves and deal killers to the surface better than actually touring several properties and their respective neighborhoods. 

Sometimes several of the tenant’s stated priorities are in flux and I find it helpful to keep track of the properties we have viewed with a scorecard that rates key criteria on a scale (I like 1-5; 1-100 or even 1-10 risks everyone getting lost in the weeds.)  Here is a list of criteria I rated for a client recently:

  • Budget – budget often evolves from the tenant’s original rent target.  When it comes to the economics of a given space, employee satisfaction and productivity trump rent.
  • Parking – abundance and security were key parking considerations for this client
  • Proximity to neighborhood amenities – the client wanted to be in a walkable neighborhood where their employees felt safe and where there was an array of food and personal services available.
  • Proximity to client’s manufacturing facility – as our touring progressed, neighborhood amenities moved ahead of being close to the industrial submarket where they manufacture their products and this slid down the priority list.
  • Proximity to other business in the same industry and industry-supporting services – this matters when you are in the fashion or media industry but not so much if you are an accounting firm.
  • Building and premises image and functionality – they valued a creative office environment and lots of natural light.

When I introduced the client to the scorecard I made it clear that it was not intended as a tool to choose a property based on the overall highest score; rather, it was a way to consciously take stock of their shifting priorities and steer clear of confusion that can derail what is always a complex decision. 

In the end, the tenant got the location they wanted and just as importantly, knows how they got there.


Getting Creative With Creative Office

One of the hallmarks of “creative office” space is the deconstruction of the walls that divide everybody and the collaboration and fresh ideas that spring from large, open spaces. Many of the images we see are of the most dramatic spaces created for large tech juggernauts. While these pictures are eye-popping, they also tend to scare off small and mid-sized business in more traditional industries. But fear not – creative concepts can be applied in smaller offices with great functional and aesthetic effect.

I am working with a regional accounting firm eager to change the feel of their space. This desire is motivated by the most profound reason: they know that they are competing with other firms to attract the best and brightest millennial accounting talent and want to present an environment that is cool and alluring. Want to know the secret to achieving this goal in a traditional office building setting? One word: furnishings.

Most people think of bow truss overhead structures, exposed air conditioning ducting, and concrete floors when creative office is mentioned but furniture systems are at the root of the functionality of creative space. Work surfaces are replacing work stations. Task seating is critical to wellness and productivity over the long term. Soft seating with style contributes mood enhancing color and, well…style.

For the accounting firm remodeling their existing offices, we started with a fresh space plan that carved out the open space. Then I set up a meeting with one of the largest dealers of modern office furnishings who could not only present a vast array of new concepts and materials, but could help them with the design and “spirit” of the space.

“Creative” not only describes the finished space but the inspiring process of getting there. Get a good broker on your team who can lead the way…and have fun!

The Hidden Value In A Lease Option To Renew

The lease option is one of the most common add-ons to a commercial lease and is more often than not granted by the landlord when asked for.  When the landlord drafts the lease they drop in their standard lease rider or amendment language.  There it is: the tenant may renew the lease for five years (typically) so long as they give the landlord advance written notice by a defined deadline.  End of story. 

No…it isn’t!  Also commonly found in option language is a clause that states that the option is “personal” to the party who signed the lease and cannot be transferred.  Most tenants don’t give much consideration to the possibility of assigning their lease down the road and so they don’t give this much thought.  But consider the following real situation I just negotiated for a retail service business in West Hollywood:

The shop space is in a burgeoning retail district in town that is experiencing exploding rents just a block to the west.  First, we were able to negotiate a set rent for the option period, so we avoided surprises that can come with a “fair market rent” reset.  Then I asked to delete the sentence that said that the extension option was not transferrable.  The landlord did not hold a strong position on this language – it has just been in their leases since time immemorial – and so he agreed to the change.

Now let’s project into the future.  The tenant decides for whatever reason to sell the business a few years down the line.  Let’s say there are three years left on the lease.  The high rents from a block over have migrated into my client’s neighborhood making the rent we negotiated well below market.  Having eight years of below market rent (three remaining on the original term plus five in the option) versus just three could positively impact the value of this business by $500,000.

Now that’s keeping your options open.

A New Location Involves So Much More Than Real Estate

It is time to find a new location for your business.  You know this is going to be a time consuming pain in the neck, so you call your trusted tenant rep broker – your advocate for all things real estate – and give the command to get started. 

No doubt, a move is arduous and complicated, but it’s not just about real estate.  Every professional advisor that your business depends on gets involved in a change this big; indeed, your corporate attorney, your CFO, your outside accountant, your insurance agent, and your HR department all have a role to play.  And the outside business growth consultants that you recently engaged to help steer your business to a successful future?  Yeah, them too.

Your real estate broker is the scout that runs out in front of the expedition, reporting back on market trends and available space for lease or purchase.   But it is also the broker’s role to know how each professional on the tenant’s team will be processing that information.  In particular, the broker would be wise to open a line of communication with the growth consultant to insure their efforts are coordinated to achieve a common goal.    I often encounter tenants who do not fully appreciate the teamwork involved.  As the consultant that initiates the relocation process, I am in a position to call to their attention the need to draw their other business experts into the fold.

The real estate broker may run ahead of the pack at first, but a lone wolf could jeopardize your goals. 

The Varied Reasons For Picking A Business Location

The rise of new business sectors is pulling us back to the old cliché concerning the three fundamental rules of real estate: location, location, location. 

When you look at the most expensive office submarkets in Los Angeles you might wonder why firms would choose to locate there when there are so many lower cost alternatives.  Very rarely is more than a few cents per square foot of the rent premium related to the physical attributes of the building and its amenities.  Similarly, only a few cents differentiate the prominent location on a major street with a building located on a secondary artery (on L.A.’s Westside, think Wilshire Blvd. vs. Olympic Blvd.)  It is business synergy and the people behind it that creates a “have-to-be-there” location .  For once, the developers can’t even take credit!

The classic example in Southern California is Silicon Beach, the submarket originally comprised of Santa Monica and Venice.  Due to demand pressures, its borders have since expanded.  Within those boundaries is a culture of adventurous, entrepreneurial creativity that has become a vital jolt of energy to every one of the businesses there.  Thus, you have firms willing to pay nearly double what they would have to pay in, say Westwood, barely 4 miles away. 

I toured a social media app client through Santa Monica recently to look at buildings to lease.  Parking is impossibly scarce, mid-afternoon traffic is mind-numbing (and blood pressure-raising).  But in one building, we crossed paths with another young tech worker.  When she introduced herself to my client and they realized they were big fans of each other’s tech offerings, the connection was palpable.    And the value?  Arguably, priceless.

Sometimes there is a submarket where your business just has to be.  When that is the case, you still need a good real estate broker advocating for you and negotiating aggressively on many fronts.  But the rental rate may not be one of them.  

Ask Correctly and Ye Are Likely To Receive

Even the best businesses run into cash flow problems.  There are often sources of internal capital that are available to cover these dry spells including cash reserves and credit lines.  When those are not available, often the biggest help can come from the landlord the business sends their rent check to every month. 

Inexplicably, most tenants assume the fetal position when dealing with the landlord.  Think of the term – the “lord of the land.”  It’s amazing that this medieval concept has survived to the present day.  In my previous life as a property manager I often dealt with tenants begging for relief and mercy from the landlord.  Such a misguided approach to seeking financial assistance rarely got the tenant what they were asking for or what their business really needed. 

A tenant needs to approach the relationship with their landlord from a modern perspective; that is, two complimentary businesses in a contractual partnership.  When you view things in this light, the request for rent relief becomes a simple business transaction: an investment by the landlord in the tenant’s business.  Think about it: when a business solicits investors for money, they sell the positive prospects for success.  The tenant needs to characterize the trouble they are facing as a temporary setback caused by market conditions or perhaps a business miscalculation on their part.  In any event, their pitch to the landlord needs to emphasize the fact that with some help, the problem can be neutralized or reversed and that the ultimate result will be a stronger tenant who will be better able to fulfill their contract with the landlord.  

This strategy works when you get sound guidance from a good real estate broker and advocate.  I recently coached a client of mine and helped them get $60,000 of rent relief.  In addition to helping them word the request using the proper, positive tone, I advised them to propose repayment terms that would allow them to pay back the balance due ahead of schedule and leave the landlord feeling like they had made an excellent investment. 

Beats begging, doesn’t it?

For The Best Results, You Need A Great Coach

I imagine many of the readers of Lease Intelligence play golf, tennis, or another competitive sport.  The joy of getting better over time is the great allures of playing sports.  But certainly, there are aspects of your game that you would love to improve.  The difficulty of breaking through these performance barriers is a trade-off frustration.

Imagine if you had a dedicated, professional coach watching your every move.  Do you think your performance would be better?  And what if that professional coach was available at no cost – completely free to you.  Would you be all over that opportunity?

That is what an experienced tenant representation broker is – your business’ free real estate coach.

My friends, tenants are getting “the shaft” every day.  Many of you have heard me chant this over and over again.   Sometimes, they get it from the landlord.  Candidly, a lot of the time it’s self-inflicted – they don’t know what they don’t know!  Yet they go it alone, making mission-critical real estate decisions and negotiating a lease without the help of a good coach – their advocate – making sure that lease is well negotiated and tailored to their unique needs.

This is how we approach things at The Tenant Group – it is why the company was formed in the first place and why I joined their ranks last month.  Listen, we enjoy what we do.  It’s fulfilling to us.  It is our passion.  What looks like a minefield to the tenant is a road map to us.  

You call me…invite me over to your office…we sit down and talk.  We put your objectives and priorities on the table and we see if we’re a good fit.  I mean, my clients love me but I’m not right for everybody!  But in any event, don’t go it alone.  You really do need an advocate when you’re looking to lease or buy commercial real estate

Don't Be Paralyzed by Fear

In every lease I negotiate, I find my years of experience managing properties for the landlord of immeasurable value.  My understanding the landlord’s business guides me to negotiate where I know I can get great results for the tenant and helps me set the tenants expectations where I know the landlord will be immovable.  This varies from deal to deal and an experienced tenant rep broker can tune in to the economic forces at play in every situation.

One of the more challenging terms to negotiate is the rent for future renewal options.  Most landlords default to “fair market value”.  I always try to fix the option rates for my clients, but sometimes the landlord digs in his heels and the best I can do is negotiate in the lease language to insure “fair market value” must be arrived at fairly and cannot be set arbitrarily by the landlord.   As lease terms get longer and options are further out in the future, it is time to concede that “FMV” is really just fair to the landlord.  I have to explain to my tenant clients sometimes the fundamental principle of the landlord’s business: with the risks they assume when they invest in property, they are entitled to reap the rewards of an improving market. 

 I had a client who was looking to lease retail space in downtown L.A.  We negotiated a ten year lease and managed to cap the rent increase for the first five year option, but the landlord held firm on FMV rent for the second option.  We are talking about 15 years down the line.  The tenant was mortified.  “The landlord could double or triple my rent!  I can’t stand it!”  I had to talk my client off the ledge.  I did so by explaining that fair market rent is what a reasonably successful tenant can afford to pay on a sustainable basis.  To set the rent at a higher level only guarantees that the landlord will have a failed tenant and a vacant store.   And if this client’s business was still in this location 15 years from now, chances are he is operating a reasonably successful store!

Risk is inherent in commercial real estate whether you are a landlord or a tenant.  Don’t be paralyzed by irrational fears.

Search For Answers

I wish I could tell you I have all the answers but I do not.  (Alert the media!)  Grave concerns perceived by my clients show up during lease and purchase negotiations that I cannot resolve with persuasion or market knowledge.  Do you have kids?  Ever notice how your child will take an outsiders advice more seriously than yours?  OK, now we’re on the same page.

When negotiations get into crunch mode and the deal is on the line, the tenant may begin to wonder whether their broker’s advice is offered in their best interests or in the interest of closing a deal and collecting a commission.  That is when I often call in outside experts that can provide facts and perspective that will lead to a wise decision by the tenant that really does support their objectives.  These outside resources include attorneys, accountants, bankers, architects, contractors, and entitlement consultants.   And as a tenant advocate, I have a large stable of them.

In one recent deal, my client was negotiating to purchase a property for development in a , shall we say,  “controversial” submarket from a seller who had been pursuing entitlements to do his own development.  My client maintained what I thought was an overly pessimistic opinion of whether and when the entitlements could be secured.  The parties were at an impasse and talks stalled.  I knew that arguing my case would only have been self-serving.  So I got permission from the seller to have his entitlement consultant meet with my client.  The informed intelligence of this consultant answered my client’s questions, put his mind at ease, and got the negotiations moving forward again.

A good tenant broker will search for clarity…and go to the ends of the Earth to find it.

The Best Way To Negotiate The Base Year For Operating Expenses

In a recent post, I reminded all tenants to pay close attention to landlord communications about operating expenses.  Today, I am going to share with you one very easy (and almost always successful) negotiating tip that will definitely save you money.

If your lease is Full Service Gross (typical for office buildings) or Modified Gross (office buildings and industrial properties), certain expenses are passed through to you only to the extent they increase over the cost incurred by the landlord in the first year or “Base Year”.  The Base Year is usually defined as the calendar year in which your lease commences.  No problem so far. 

The lease goes on to say that you will be billed for increases in those expenses in subsequent years.  That’s logical…but look out.  Let’s say your lease commenced in July of 2015.  Chances are that would make 2015 your base year and allow the landlord to start billing  your share of operating expense increases on January 1, 2016.  What was touted as a base “year” only really got you six months of protection. 

How to avoid getting the shaft?  Simply have your broker-advocate insist on lease language that says you will not be responsible for any pass through costs for the first 12 months of the lease term.  That right there would likely save a class A office building tenant $.45 per square foot over that six month period.  If your leased space is 10,000 square feet, that’s $4,500.00, thank you very much.  (Call or email me for a quick explanation of the math.)

A penny saved in smart lease negotiations is a penny earned for your business.

Pick Your Landlord Wisely

When you are looking at a number of potential locations, it is not unusual to become  preoccupied with data comparison: square footage, load factors (don’t know what that is?  You need an advocate who does!), base rent, concessions, operating expenses, and on and on.  Sometimes the distillation of this data will point you to a preferred site.  But there is another often underestimated factor to be considered: the landlord.

Evaluating the landlord is more art than science.   Consider that a “Class A” office building is often defined by size and on-site staff.  But it’s the landlord’s attitude toward the building that puts the “Class” in Class A.  Does the landlord have a reputation for seeing tenants as their most precious commodity or as a nuisance?  This attitude doesn’t appear on the page of their counteroffer or even on their website.  But a seasoned broker knows or can see the telltale signs in the management of the property.

Sometimes the magic is in matching the agendas of the two parties.  I recently ended a one year search for the perfect building for an aerospace manufacturing client.  The building I found was not at all remarkable from the outside but a new owner had just taken over the building and in an effort to restore the building’s value and curb appeal, had his checkbook out and was undertaking property-wide upgrades.  I caught him at the perfect moment.  I introduced the tenant and suggested he redirect his capital investment to tailor the building for their needs.  Done deal and our search was over!  It helped tremendously that this landlord takes great pride in their investments and holds them for a long time.

I am presently working with a unique, niche bakery searching for the perfect location in downtown Los Angeles.  We looked at several properties.  One stood out in both of our minds.  The reason?  In the tenant’s words (reflecting on the landlord), “He is cool, and he gets it.”  That may sound esoteric but it is absolutely on point.  So much more can be accomplished with a landlord who is truly enthusiastic about the tenant’s business, especially with retail real estate.

Don’t miss the forest for the trees – choosing the right landlord is crucial! 

The Complex Economics of Choosing a Location

When you ask most businesses what first comes to mind when you say the two words “location” and “economics”, they might answer high rent versus low rent.  This answer is on point and shows up right on page one of the lease.  But stopping the analysis there could be a costly mistake.  There are many aspects of location that can have a real impact on your economy – your business’ bottom line.   

The City of Los Angeles has its gross receipts tax – a controversial charge levied on all businesses operating in the City at varying rates up to 5%.  That top tier will be reduced to just 4.75% in 2016.  Oh, happy day!  That alone might motivate you to consider other surrounding incorporated cities like Burbank, Pasadena, Glendale, El Segundo, Culver City, and West Hollywood.  On the other hand, the city, bowing to this competitive disadvantage has established a three year moratorium on the tax for new businesses starting in or moving to the City of Los Angeles.  Indeed, there may be very compelling reasons to locate in downtown L.A. or Century City, but it’s always best to be forewarned and to include city taxes in your occupancy cost analysis.

California’s Proposition 13 has been on the books now for 37 years but remains a double edged sword for commercial real estate tenants.  Given that increases in real estate taxes are passed through to tenants in most cases, the cap on year over year property tax increases set by Prop. 13 is a blessing.  But you can get blindsided by huge increases when the property you are leasing is sold and reassessed.  How to protect against this?  Have your broker research how long the current landlord has owned the property.  If it has been more than 10 years, the increases in the event of a sale are likely to be big.  And do not believe the landlord or their agent when they tell you that they plan to hold on to the property forever.  It’s an all too familiar refrain that you cannot hold them to!  

It pays big time to have an experienced real estate broker in your corner bringing up these challenging issues and advocating your best interests when negotiating your lease.  

Two heads are better than one and might just spare you a migraine.

"Creative Office" Moving From the Fringe to the Middle

Once and for all, let’s put the worn out term “Creative Office” behind us.  Used to describe the workplace of technology startups and flip flop-wearing millenials, the term was abused and perverted by the real estate profession, I’m sorry to say.  First and worst of all, they tried to define creative office by a type of building (old, obsolete industrial buildings) and where it was likely to be found.  The archetypal locations in the Los Angeles region have been Santa Monica, Venice, El Segundo, Culver City, Hollywood, and the Arts District in downtown L.A.  But the misguided definitions of building construction and zip code missed the point.  The emerging new concepts about the communal office are about the people and the work – and it can take place anywhere that a community can thrive.  

The “Creative Office” cliché is being crushed in downtown Los Angeles.  In the midst of a breathtaking renaissance, young entrepreneurs and professionals are flocking to the city’s long forgotten core to live, work and play…and eat…and drink (craft beer, anyone?)  And in everyone’s view is Bunker Hill, home to the city’s largest concentration of skyscrapers.  Where better to challenge the notion that the new office space paradigm is exclusive to low-slung, worn down buildings?

If the primary creative office precept is collaboration, then it can flourish in a dense, vertical downtown community brimming with cultural institutions and richly programmed public spaces.   It is starting to happen.  Brookfield Office Properties’ experimental  DesignHive of six bleeding-edge spec suites in two of their Bunker Hill Towers is a must-see.  I would be happy to give you a tour.

Another perception that is being trashed is that “Creative Office” is just for technology companies.   I have accounting and insurance clients that are shifting to more open plan, team work layouts.  No longer relegated to the “creative” pigeon hole, a new paradigm of productive office space is here.  All aboard

Operating Expenses Can Be a Minefield

If you are a tenant at a property with a single building, your share of operating expenses and property taxes is an easy concept to understand.   But in most multi-tenant office buildings, leases are structured as “Full Service Gross” where the rent includes the tenant’s share of operating expenses for the first year, or “base year” of the lease; in subsequent years, the tenant is charged only for increases over those base year expenses.  Are you confused already?  It’s not unusual.  All the more reason to have a knowledgeable advocate in your corner. 

The calculation of these increases is where tenants can be cheated.  For instance, what if you leased space in a building that was 50% occupied.  Would the building’s electricity expenses be lower that year than in a future year when the building is 85% occupied?  Absolutely yes.   Let’s do a little quick math.  If you occupied 5% of the building and the base year electricity cost was $25,000, 5% would be $1,250.  In that future year with the occupancy up to 85%, the electricity cost is $42,500 and your share is $2,125.  Therefore, your share of the increase over the base year is $875. 

But wait.  Look at a utility bill in each of the two years.  The utility’s rate per kilowatt hour has not changed!  If this doesn’t seem fair, you are right – you are being ripped off!  A well written lease should state that occupancy-sensitive operating expenses (like utilities and janitorial services) for the base year and all future years must be adjusted to reflect an occupancy constant like 90% or 95%.  If that rule is in the lease and properly adhered to, the increase of electricity costs over the base year charged to you in the scenario above would be zero.

A good real estate broker with some property management experience will have your back.  Be sure you have one looking over your shoulder.   It could save you an arm and a leg.