Wednesday, February 7, 2007

Landlords are Charging tenants for capital improvements

Some lease charge tenants for all capital costs as an operating expense, presumably on the grounds that if you do not ask, you do not get. If read literally, that would make a tenant who is in the building at the time a roof is replaced liable for its prorate share, in a single year, of the entire cost of the roof, ignoring that the expected life span of the new roof far exceeds the term of the lease.
Capital costs are usually predictable years in advance (and so are already a component of base rent), or are usually covered by insurance if arising from force majeure, etc. The clause (in the BOMA publication) is fair, in that it offers to amortize the cost.
But it still charges the tenant for capital costs and the underlying principle is still at stake.
Another common compromise is to charge the tenant only for capital costs that reduce, or are intended to reduce – what would otherwise be operating expenses – or the rate of increase in operating expenses – so that the landlord at least recovers the cost of expense- saving equipment.
There may still be some further negotiation, such as a tenant request that the amount passed-through to the tenant under such a clause not exceed, in any given operating year, the amount of operating expense savings realized. This sounds fair but is extremely difficult to calculate, particularly given outside variables (such as the weather, the comparative cost per gallon of fuel oil). The advantage of such a clause may be that the tenant has no greater ability to challenge such a determination itself, is unlikely to audit operating expenses anyway, and its outside auditor also probably lacks the expertise to seriously challenge such a determination by the landlord." From : Guide to Writing a Commercial Real Estate Lease, published by Building Owners and Managers Association International (BOMA) For more info: contact www.houstonrealtyadvisors.net ask for Ed A. Ayres ; President