The Big Unknown: Operating Expenses

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One of the things that can complicate your budget for office rent is operating expenses.  There are two ways your landlord can handle these costs.  The first is simple – if it’s $12.00, he charges you $12.00 or $1.00 per square foot per month and you are done.  This is known as a triple net lease (NNN).  The other method is over a Base Year.  This means that in Year One of your lease that $12.00 is included in your rent number, but you’ll pay the difference in subsequent years.  So if your operating expenses increase by $0.25 in Year Two, you’ll pay that difference either in a lump sum or in 12 installments – it depends on your lease.

What do these two methods have in common?  Uncertainty.    You’ll never know exactly how much this cost will be each year.  Operating Expenses fluctuate and simple things like an increase in the minimum wage could trigger an added cost to you because it affects the landscaping and janitorial costs of your property.  Sometimes when a property sells, the real estate taxes increase and this is passed on to the tenants.  Sometimes they even decrease.  So how do you try to accurately forecast this unknown?

The first thing is to ask your landlord for a 3+ year history of the operating expenses.  This allows you to see how these expenses have been tracking.  If you see wide variations, ask for an explanation.  The next  thing you can ask for is a cap on your operating expenses.  This works to a certain degree.  Landlords typically only allow a cap on the “controllable” expenses which are items that they feel they can control the cost.  It would exclude property taxes and utilities, for example.

One of the things I do for my clients is help them accurately forecast these unknown expenses.  When we are looking at a long-term lease, I prepare an analysis that looks at all the costs in the transaction.  Let me help you with your upcoming lease negotiation.  I have done literally hundreds of these negotiations and can insure that your interests come first.

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