What You Need To Know About Gross Up Provisions In Commercial Leases
Depending on the type of lease, the tenant may bear all or only a portion of the landlord's expenses. In a "triple net lease," all of the landlord's operating expenses are passed on to the tenant. A lease may, however, contain an "expense stop" which establishes a point at which expenses begin to be passed on to the tenant. In this type of lease, expenses for a "base year" are determined - the expense stop. Thereafter, the landlord pays expenses equal to the base year and the tenant pays its pro rata share of the rest. For example, if a lease contained an expense stop at $10,000 ("base year" expenses), and the landlord's operating expenses were actually $11,000, the tenant would pay the $1,000 over the expense stop.It has become more common in recent years for office leases to contain what's referred to as a "gross up" provision. Gross up provisions permit landlords to "gross-up", or overstate, operating expenses to simulate the building being at full capacity.
Here's how a gross up provision would work in the real world:
Assume the gross up provision states that common area maintenance expenses will be calculated for each tenant as if the building was fully occupied, or at 100% capacity. Further assume the building is currently only at 50% occupancy.
Under this set of facts, a $1,000 expense to the landlord would be multiplied by a gross up factor of 2 (100% (the markup rate) / 50% (the level of occupancy)). $1,000 x 2 = $2,000 (the grossed up operating expense). The tenant is required to pay a pro rata share based on the percentage of space it occupies - let's assume 20%. In this scenario, the tenant's total grossed up obligation would be $400.So, what exactly are the advantages and disadvantages of including gross up provisions in a commercial lease?
From the landlord's perspective, the most obvious benefit of a gross up provision is being able to pass on the expenses resulting from building vacancies to the tenants. Gross up provisions are generally viewed as reasonable for certain expenses, such as utilities that are not separately metered, because the landlord will bear that expense for the entire building even though it is only partially leased. These expenses do not vary by occupancy levels.
Although a gross up provision may seem disadvantageous to a tenant on its face, it can actually benefit the tenant under certain circumstances. For example, referring back to the lease which includes an expense stop - if a building is not fully occupied during the base year, a gross up provision overstates the expenses based on full occupancy. This protects tenants from sudden increases in operating expenses when the building becomes fully occupied later. Essentially, the gross up provision for a property not fully occupied results in a higher expense stop. In the absence of a gross up provision and less than full occupancy, the tenant's expense stop will be lower resulting in higher increases in future years when the building becomes fully occupied.
As demonstrated by the above discussion, gross up provisions can drastically impact the terms of a commercial lease agreement. Prior to entering into a commercial lease agreement, make sure to consult with a San Diego commercial lease attorney.
Problems arise where either the landlord or the tenant misconstrue respective responsibilities. When this happens, commercial tenants are tempted to make the needed repairs and simply deduct the cost from their monthly rent. Unfortunately, this commonly referred to "repair and deduct" remedy is not available to commercial tenants unless the remedy is specifically provided for in the lease. Even if the repair and deduct remedy is provided for under the lease, commercial tenants need to be careful about what repairs the landlord is legitimately responsible for under the terms of the lease. Commercial tenants that mistakenly withhold rent for repairs that weren't the landlord's responsibility or where the lease doesn't specifically provide for the "repair and deduct" remedy risk being
Those tenants that entered into leases without review or who were unable to negotiate better terms often find themselves dealing with landlord breaches. Some withhold rent immediately not realizing that they might be held in breach of
Most retail leases are triple net leases and the
For example, consider a property that has not changed ownership in ten years (meaning it has not been reassessed for Proposition 13 purposes in ten years). In 1994, at the time the property last changed ownership, its value was assessed at $10,000.000.00. Assuming maximum Proposition 13 increases annually of 2%, in 2003 the Proposition 13 tax basis for the property would be $12,189,944. At a tax rate of 1.5%, the tax on the property in 2003 would be $182,849.00 (12,189,944 X .015). A new tenant in 2003 with a 10% pro rat share of property expenses under a triple net lease would owe $18,285 in taxes for 2003. Typically, these taxes are anticipated and paid by tenants as part their monthly
A recapture clause allows a landlord to terminate the lease and take back possession of the premises upon the occurrence of certain conditions. It is usually associated with complex "assignment and subletting" clauses that allow tenants, upon landlord's approval, to assign their lease or to sublet a part of the leased premises to a third party. Landlords like to include "recapture clauses" that are triggered by a tenant's mere request for the approval of an assignment or subletting.
The best first step towards improved management of CAM expenses is for property managers to simply pay attention. Supervision of maintenance operations ensures that waste is kept to a minimum. If or when a tenant does question a specific expense, the landlord will be prepared to produce relevant invoices and explain why the expenses were necessary. This is especially important for anchor tenants who typically have the resources to challenge landlords' accountings. Too often property managers ignore potential problems hoping that the tenant will either forget about it or accept an evasive answer for fear of creating conflict. What property managers tend to overlook is that tenants have long memories. If later problems arise or if business starts to decline (for whatever reason), tenants inevitably latch onto the older seemingly innocuous issues and the landlord/tenant relationship can deteriorate rapidly. Regardless of the tenant's size, experienced property managers know the headaches this can create.
Paragraph 12 - Assignment and Subletting: The AIR lease does not address circumstances where an assignment results in net profit to the tenant. Landlords and tenants should work with their attorneys to include lease language that defines profits in such situations and how those profits are to be divided.
Paragraph 4.2(a)(ix) passes on the costs of capital improvements to the tenants. This is also common in commercial leases. The AIR lease calls for the costs to be amortized over 12 years reducing the tenants' monthly burden. However, this burden may still be significant depending on the size of the commercial property and the particular premises leased. This can be especially problematic for smaller businesses leasing space in a smaller commercial property. If the business leases 25% of the space from a 50,000 square foot strip mall and the lessor decides to completely remodel the property at a cost of $500,000.00 , the business' monthly obligation increases an additional $868.00 not including any additional
In general: The parties to a commercial lease should always be acutely aware of important terms and definitions such as Premises, Common Areas, 
