Operating Cost Provisions in Commercial Leases: Inclusions and Exclusions, and Gross-up, Guidance for Landlords and Tenants

Commercial lease agreements often apportion a pro-rata share of the building's operating expenses to tenants. Beyond fixed expenses like insurance and taxes, tenants also share variable costs for building operations, such as maintenance, repairs, employee expenses and utilities. As expected, these provisions divide costs among tenants based on their share of leased square footage--a relatively straightforward exercise.

When negotiating commercial leases these expenses that are passed through need to be as inclusive as possible from the landlord’s standpoint, and as well-defined and limited as possible from the tenant’s posture. We will discuss negotiated inclusion and inclusions.

Variable expenses generally fluctuate based on occupancy and from month to month during a tenancy. Office lease landlords often rely on the concept of "grossing up" the tenant's share such that the costs will reflect the costs expected as if the building is fully occupied.

This practice benefits landlords by shifting some vacant space operating expenses to the building's current tenants. While considered one-sided to the uninitiated, well-drafted gross-up provisions can benefit tenants when operating costs are part of a base-year amount. The tenant is only responsible for its pro rata share of operating expenses that exceed the base year.

Listen as our expert panel discusses drafting, negotiation, and the pitfalls of operating cost provisions and gross-ups in commercial leases. The panel will provide an overview of their benefits for landlords and practical guidance for balancing the associated risks for commercial tenants.

1. Defining gross-up
   1. Fixed vs. variable expenses
   2. Interplay with other expense provisions
2. Landlord perspectives
   1. Goals in drafting
   2. Protections
   3. Avoiding pitfalls
3. Tenant perspectives
   1. Goals in drafting
   2. Protections
   3. Avoiding pitfalls

The panel will review these and other high priority issues:

• What operating expenses can landlords include and what operating expenses can tenants try to exclude?
• How can commercial tenants use gross-up provisions to avoid spikes in their pro rata share of operating expenses after the base year?
• What additional provisions should counsel consider when negotiating and drafting gross-up and operating cost clauses?
• How can landlords best use gross-up and operating cost provisions in properties slated for or undergoing green renovations?