The Rise of Uncontrollable Operating Expenses. What Tenants Can Do To Protect Themselves

In today’s commercial real estate market, tenants are increasingly facing a growing challenge: the rise of uncontrollable operating expenses. As a lease administration company, we process and analyze hundreds of invoices and operating expense reconciliations for clients across the country. A concerning trend we’ve observed in recent years is the consistent increase in operating expenses that can dramatically affect a tenant’s bottom line. These costs—often outside the tenant’s control—can include taxes, insurance, maintenance, and utilities, among others. As costs continue to rise, it’s crucial for tenants to protect themselves.

Understanding the Issue

The rise in uncontrollable operating expenses can be attributed to various factors:

1. Inflation: General increases in the cost of goods and services affect building maintenance and operations.
2. Energy costs: Fluctuating energy prices can lead to unpredictable utility expenses.
3. Property tax increases: As property values rise, so do the associated taxes (with the exception of California).
4. Insurance premiums: Increasing natural disasters and other risks have led to higher insurance costs.
5. Labor costs: Rising wages and benefits for building staff contribute to higher operating expenses.

These factors, often beyond the control of both landlords and tenants, can lead to substantial year-over-year increases in operating expenses. However, there are steps tenants can take to protect themselves from these rising costs.

Strategies for Tenant Protection

Cap on All Operating Expenses

• While it may be difficult to secure, especially with sophisticated landlords, a cap on all operating expenses is worth the effort for tenants.
• Aim for a reasonable annual increase limit, such as 3-6% per year.
• If a total cap is not achievable, try to negotiate caps on specific expense categories, like utilities or property taxes.

Focus on What Can be Controlled

• While some expenses—such as property taxes, utilities, and insurance—are largely outside of a landlord’s control, other areas offer more flexibility. Tenants should focus on these areas to minimize their financial exposure. For example, building services and maintenance can often be managed through proactive measures.
• Aim for a 3-6% annual increase cap on controllable expenses. A good property manager should be able to limit increases under the cap. If the landlord refuses to provide a cap, that could be a red flag.
• For tenants that occupy all or a large portion of a building, request the right to approve or veto certain discretionary expenses, such as large maintenance projects that may not be necessary.

Make Sure Base Years are Reset When the Lease is Extended

• When extending a lease with a base year, ensure the base year for operating expenses is reset for the renewal commencement year.
• This ensures that you’re not paying for cumulative increases from previous years.
• The base rent for the renewal term will be based on the current market. By resetting the base year, tenants ensure that their share of operating costs reflects the current market, rather than inflated costs that have built up over previous years.

Audit Operating Expense Statements

• Regular audits of operating expense statements can uncover errors or misallocations.
• Negotiate for the right to audit in your lease agreement.
• Consider hiring a professional lease auditor to review statements thoroughly.
• Look for issues such as:
  • Improper expense categorization
  • Calculation errors
  • Charges for items excluded in the lease

Negotiate Expense Exclusions

• Work with your lease administration team to identify common expenses that can be excluded from your responsibility.
• Examples might include:
  • Capital expenditures
  • Costs related to other tenants’ spaces
  • Management fees above a certain percentage
  • Expenses related to lease enforcement for other tenants

Final Thoughts

The rise of uncontrollable building expenses is an issue that is unlikely to disappear anytime soon. However, tenants can protect themselves by staying vigilant, negotiating favorable lease terms, and actively managing the costs they can control. Whether it’s securing a cap on operating expenses, resetting the base year during lease renewals, or conducting regular audits, tenants have tools at their disposal to safeguard their financial interests.

In the ever-changing world of commercial real estate, proactive lease administration can make all the difference between a smooth, cost-effective lease and one where expenses spiral out of control. Taking the time to implement these strategies can help tenants avoid unpleasant surprises and keep operating costs in check as they navigate the years ahead.