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A Commercial Leasing Primer on Additional Rent

Posted by Ashleigh Kiggans on May 04, 2016 Leave a comment

At the end of the day someone has to pay for all those expenses to operate the building … but “who” that someone should be remains the real question.

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It’s hard to believe that I am now entering my 4th quarter with the MacRo team. After handling a few leasing deals, it seems prospective tenants more often than not ask me the same question, “What is ‘additional' rent?”

While I know we touched on this issue in the recent post entitled Office Leasing Terms 101, I think it’s time we dig in a little deeper.

Additional Rent, which is also called and/or includes Common Area Maintenance (CAM), Operating Expenses (OPEX), or Pass Throughs, is that proportionate share of expenses that the landlord passes through to the tenant. The expenses passed through will vary depending on the property and lease type. This is most often found in what is known as a Net Lease, where all or at least a major part of common expenses is paid over and above the base rent payment.

Clients often ask me why the pass through expenses are higher in traditional office buildings in comparison to single offices, retail, warehouse or flex spaces. The reason for these differences has to do with the expenses the landlord is handling for tenants within the building. Just like any business, each year property owners review expenses from previous years in order to establish a budget for the year ahead. While landlords wish to recover expenses such as real estate taxes, insurances, management fees, and CAM costs, that is usually where similarities end.

Traditional multi-unit office building pass through expenses can range between $6.00 to $10.00 per-square-foot. I know, your first thought may be, “Wow, that will nearly double my monthly rate!”

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Though this may sound like a lot, let’s take a moment to evaluate what is included. First, office buildings tend to have a common meter for electricity, water/sewer and heating-ventilation-air conditioning (HVAC) services. In addition, janitorial and trash removal services are often included. To gain a better understanding of how Additional Rent is calculated, take a look at the annual office building expense budget chart below:

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This is a pretty extensive breakdown, but it does give you a better idea of how landlords determine the Additional Rent amount to charge their tenants. While traditional office buildings include all the expenses that come along with the building, that does not ring true for other commercial properties.

We often see warehouse, retail, and flex space pass through expenses around $2.00-$3.00 per-square-foot, with some being as low as $1.00.

Sounds great, right?

Well, not so fast. Warehouse, retail, and flex spaces are normally built to operate separately from neighboring buildings, even if they are under the same ownership. Unlike an office building, these spaces are metered separately and often not included in most of the shared expenses shown in the chart above.

The landlord typically budgets to be reimbursed for the insurance, real estate taxes, and management fees. Here’s where it begins to get…we’ll call it “blurry”. Utilities will usually be charged directly to the tenant, but landscaping, snow removal, and other common area charges are all up for negotiation as it relates to whether the landlord or the tenant will take responsibility for doing the work.

In some cases, the landlord will agree to an allowance for these services. For example, a landlord may offer the tenant the option of capping the tenant’s cost for snow removal at $2,000 per year with the landlord agreeing to pay the remainder. In agreements like this, landlords and tenants are allotted more flexibility to negotiate.

One of the benefits to lease agreements like this is that the tenant can have more cost control. A great example of this is a tenant whose business is open during non-traditional hours (not the normal 9-5ers). Since the building is on a single meter, the landlord controls the building's HVAC system. In such cases, since the majority of the building tenants aren’t working at 1 pm on a Saturday, there will most likely be minimal HVAC use in the building. So, this is why tenants who have longer or non-traditional business hours--as is the case with many retail businesses or flex/warehouse space end-users--it is best that they have complete HVAC control and are solely responsible for the bill.

There is one key thing to remember: no matter what type of space you occupy, these fees can and will INCREASE. Okay, maybe putting it in caps was a little much, but it should be top-of-mind. Much of the time, an annual increase of, say, 3% per year will cover both your Base Rent and your Additional Rent charges.

But, there are those exceptions where the verbiage in your lease indicating that Operating Expenses are “subject to change” can come into play.

In fact, many landlord snow removal budgets were blown out of the water with the 35 inches of snow we saw here in Frederick this past winter. Though such a heavy amount of snow is considered an unusual weather event for this area, landlords were faced with having to pass through the overage charges to their tenants. 

At the end of the day, it is important to understand that the Base Rent you see in your lease may not be your total monthly fee. So in cases outside of a full service or gross lease, where the rent has been elevated to cover all the pass-throughs, there are times that Additional Rent can make or break a deal.

Make sure you keep pay close attention to those costs…and your own budget!

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Topics: Commercial and Industrial Real Estate, Real Estate Wisdom, Ashleigh's Field Notes Ashleigh's Fields Notes