Avoiding Unexpected Lease Costs

[This article originally appeared in the New England Real Estate Journal, July 1, 2004.]

Tenants are well aware of the amount of rent they must pay under their leases, but many are unaware of a number of “hidden” lease costs buried within the terms of typical leases.

These hidden costs often arise due to how a key word is defined. For example, most leases require the tenant to maintain and repair some or all of its premises. How the word “premises” is defined can make a big difference. Although tenants are usually responsible for only the interior retail space, some leases define “premises” to include the exterior walls, the windows, the roof or some or all of the HVAC system. In this case, not carefully reading a definition can mean greater maintenance costs than anticipated.

Another unanticipated cost is sometimes found in the definition of “percentage interest” for the purpose of determining the tenant’s proportionate share of operating costs and taxes. If the tenant’s “percentage interest” is defined as the size of the leased premises divided by the size of the building or shopping center that is leased to other tenants, then the tenant’s percentage interest will increase if occupancy levels decline. To avoid this, tenants should insist that the percentage interest be stated as a fixed percentage.

Tenants should also watch out for leases containing operating cost pass-through clauses, coupled with annual CPI adjustments. Operating cost pass-throughs protect a landlord’s investment by shielding it from increases in operating costs over time due to inflation or other factors. When coupled with a CPI escalator, however, these clauses effectively allow a landlord to raise its base rent every year.

Provisions of retail leases requiring tenants to pay rent based upon a specified percentage of their gross sales may result in unanticipated costs as well. In these provisions, tenants should pay particular attention to items which are specifically included as “sales” and to items which should be expressly excluded from sales (such as exchanges of goods or services for an identical price; return of goods for a refund of the purchase price and bad debts).

Finally, all leases designate a date on which the tenant’s obligation to pay rent begins. If construction or fit-up work is being done, the tenant should try to ensure that the rent commencement date does not begin until construction has been satisfactorily completed and the tenant is open for business.

These are just a few of the hidden lease costs which can add up to a substantial amount over the term of a lease. Paying attention to the details can make a big difference in the bottom line.