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This LARG contains the following items:

Tenants Expand and Fine Tune Operating Cost Exclusions, and the Lease Clause Critique: 52 Pro-Tenant Common Area and Operating Cost Exclusions.

Number of Single Spaced Pages: 12



The Evolution of Pro-Tenant Exclusions to Operating Costs


How did pro-tenant riders listing common area and operating cost exclusions evolve into seven page behemoths? To answer that, rewind back to 1970. Commercial landlords were infatuated with the notion of the net lease—a deal where the tenant paid the basic monthly rent, as well as the taxes, insurance, and operating costs of the property where they took space. For landlords, it was a sublime concept.

The basic rent paid by the tenants covered the debt service for the real estate and then some, and the landlord was poised for the long term appreciation of real estate asset. If operating costs for the property went up, so what? The tenants paid all that based upon how much space they took in the building or complex.

Including Without Limitation

Pro-landlord lease forms began to sport comprehensive "omnibus" operating cost clauses requiring the tenant to pay for all costs of "owning, managing, maintaining, and operating" the complex. In addition to that sort of expansive language, these multi-page monsters (at least as far as the tenant is concerned) contained "including without limitation" lists of examples of common area or operating costs which were to be included when such costs were calculated.

As commercial tenants gained experience with that sort of clause, they began to figure out how much it could add to their rent bills. And, they started fighting back during negotiations by proposing exclusions.

Getting It All on the Table

Large commercial tenants with locations around the country began presenting their "standard form" rider at the outset of negotiations for new space. It contained a long list of excluded costs, and the tenant used it to get all operating cost issues out on the bargaining table immediately. As negotiations proceeded, tenants could agree to delete or to compromise on some or many of the exclusions depending upon their leverage in the deal.

As the years went by, tenants polished and expanded the excluded costs enumerated in their riders. Those exclusions were the heart and soul of operating cost addenda, but they were not the only provisions that pertained to operating costs. Well drafted pro-tenant riders also frequently contained language concerning audit rights, caps on increases, required projections of future costs by landlords, and the like.

Standard Fare

Many operating cost exclusions became standard fare in lease negotiations, and landlords expected them when they traded horses with well represented tenants. For example, most landlords anticipate that tenants will seek to exclude the following expenses from operating costs:

  • capital costs for the complex;
  • costs of any debt financing and ground lease rents;
  • construction costs for tenant improvements for other tenants in the complex;
  • costs covered by the landlord’s insurance; and
  • costs covered by any warranties under the landlord’s construction or equipment contracts.

Going Beyond the Mundane

But as pro-tenant riders became more sophisticated and comprehensive, they increasingly featured the following exclusions to operating or common area costs:

  • payments to landlord affiliates or subsidiaries for property management or services which exceed "market" rates;
  • costs of disputes between the landlord and other tenants in the complex concerning lease terms or interpretations of their leases;
  • costs for parking facilities other than customary monthly parking fees;
  • "takeover expenses" assumed by the landlord for space formerly occupied by tenants moving into the complex;
  • "reserves" for capital items, capital repairs, or for future bad debt or rent losses of the landlord;
  • costs associated with concessions operated by the landlord in the complex; and
  • costs of acquiring and installing fine art (paintings and sculpture) for the complex, whether for interior or exterior use.

Big Retail Fish, Little Retail Fish

"Shop space" tenants (i.e., those taking three to ten thousand square feet in retail centers) often saw preferential treatment for very large retailers or so-called "anchors" for the complex when common area or operating costs were negotiated. Landlords frequently gave concessions to department stores and "big box" retailers to induce them to take space in the center.

For example, anchor tenants were sometimes able to negotiate a flat rate for their contributions to common area costs which is substantially below what they would pay if their share was computed strictly based on floor area. Landlords anticipated the need to make such concessions to anchors, and often tailored common area or operating cost clauses to permit them:

  • first, to deduct amounts received from the center’s anchors;
  • then, to divide up the remaining operating costs for payment on a pro-rata basis by "non-anchor" tenants.

Of course, this places a disproportionate burden for common area or operating costs on the smaller tenants in the complex. As a result, some smaller retailers bargain for language which protects them from paying more due to disproportionately low contributions made by the center’s anchors.

52 Pro-Tenant Common Area and Operating Cost Exclusions

The list of operating cost exclusions that follows contains fifty-two exclusions to pro-landlord operating cost clauses in pro-landlord form leases. Generally the language appearing in pro-landlord lease forms defining permissible common area maintenance and operating costs is extremely broad. The exclusions which follow are designed to restrict that broad pro-landlord verbiage by limiting the types of items which may be passed through to tenants for payment on a pro-rata basis.

Other important issues for the tenant relating to common area and operating costs—such as audit rights, base year and base amount issues, and the mechanics of how costs are computed and paid—are not included.


End of Excerpt