Hidden Costs in Lease Operating Expenses
When a tenant signs a lease, the business owner often adds up the rent payments under the lease and thinks that is the total extent of the obligation. However, there are “Operating Expenses” in every lease that are effectively additional rent to the tenant. These Operating Expenses are the taxes, damage and destruction insurance and common area maintenance expenses that the landlord incurs to maintain the building.
In an office lease, these common area maintenance expenses are extensive. They include: janitorial services; utilities of gas, water and electricity; repairs and maintenance to all of the building systems including elevator, HVAC systems, electrical and plumbing; amortizations of capital replacements for the roof, HVAC and other building systems; property management fees and reimbursements for labor—the list is virtually endless–and landlords have great liberties in most leases with what they can include in these expenses. In industrial and lab leases, the extent of these costs is more limited, generally because the tenant is maintaining the inside of their premises, versus the landlord providing for interior maintenance in an office lease.
Just to put it in perspective, the typical office building has aggregate Operating Expenses from $.80-$1.20 per square foot per month. The typical lab building has Operating Expenses from $.40-$.80 per square foot per month. For industrial space, it’s less at $.20-$.35 per square foot per month. Relative to the lease rate you pay, it’s anywhere from 30% to 50% of your total rent dollar paid. This is real money we are talking about here.
In an office lease, these Operating Expenses are part of the “full service gross” or “net of electricity” rent—they are in the math. In an industrial or lab lease, they are in addition to the “triple net” rent in the lease. Thus, office tenants are lured into a false sense of security that they don’t have the exposure during the lease term for these costs that an industrial or lab tenant might. What most business owners don’t realize is leases are written to provide the landlord with the ability to pass through increases in these expenses with little incentive to maintain costs. In fact, when it comes to landlords getting their costs of business operations back, leases generally allow the landlord to charge rent for their staff, their staff benefits, their management office and property management fees. This is likely the biggest area of conflict, as landlords use this broad description to pass through all of their costs of doing business to the tenants.
We have seen extensive abuse in this area where landlords are increasing the Operating Expenses over the term by passing through their increases in staff. This is done when landlords put their general administrative payroll (versus those people directly and exclusively servicing the building) into additional Operating Expenses. If they have anyone that is not directly providing services to the building in the Operating Expenses, it’s tantamount to fraud. We have seen leasing personnel, regional managers and other such personnel (and their benefits and office space costs!) passed through to tenants.
Landlords also charge a property management fee of anywhere from 2%-5% of the rent as a fee to manage the building. If a tenant doesn’t negotiate the fee in advance, certainly the tenant should expect fees to be on the high side of that scale. If the building is a large single-tenant building, the fee should be on the low side. For small multi-tenant and complex office buildings, the fee is generally on the higher side. However, that fee should provide the landlord adequate reimbursement for all of the management services and costs. Some landlords, like Kilroy Realty, are good on this. Others we have found are charging the management fee, and then charging again for all of the payroll and benefits of their staff, in effect more than doubling the management costs that the tenant pays. The net effect is that tenants pay more, and landlords have the technical right to make them do so.
Some of the most disingenuous building Operating Expense reimbursements are the ones that I saw 20 years ago with then one of the largest landlords in town, Trammell Crow Company. At end of year Holiday time, they would distribute poinsettias to all of the tenants in their buildings, and then pass that cost through as an Operating Expense. That same owner would hold a tenant appreciation day with the Padres, and have a great tailgate party for 1,000 people—all reimbursed as Operating Expenses to the tenants of each project.
This is the time of year that CFO’s and business owners get their annual Operating Expense statement from the building owners, or property managers. These statements are typically very brief, vague and offer few real clues as to how the landlord spent money last year. If you have ever received one of these, you can bet last year’s expenses were higher than the year before, and they almost always request an increase for the upcoming year. Naturally costs go up, but are the cost increases legitimate? Is accounting consistently applied from year to year?
The finance executive for the tenant often just writes the check, as they don’t know the questions to ask, or where to begin to look for inconsistencies. In response to seeing the millions of dollars of our clients’ money that gets paid every year just slip through the cracks, we have responded with the creation of Hughes Marino LAS (Lease Audit Services). As we continue to seek to add value to our client’s bottom line, we can get them a great lease, but now there is a new sheriff in town to provide some enforcement.
David Marino is Executive Vice President of Hughes Marino, a San Diego commercial real estate company specializing in San Diego tenant representation and building purchases. Contact David direct at (619) 238-2111 or email@example.com to learn more.
David Marino is executive vice president of Hughes Marino, as well as a monthly columnist for the San Diego Metro. Specializing in high-value, time-critical and complex transactions for technology, life science, and business service companies, David has been featured in the San Diego Union Tribune, San Diego Business Journal, Smart Business San Diego, and Western Real Estate Journal.
Jason Hughes is president and CEO of Hughes Marino, as well as a featured columnist for the San Diego Business Journal and past columnist for the San Diego Daily Transcript. Jason has written well over 100 articles, is a real estate resource for the Wall Street Journal, and has been profiled in the San Diego Union Tribune, San Diego Business Journal, San Diego Daily Transcript, San Diego Metro, Smart Business San Diego, California Real Estate Journal, and Western Real Estate Business.
Nik Bandak is project manager for Hughes Marino CM. Nik earned a degree in Financial Services from Saint Mary’s College of California where he graduated with honors. As a project engineer, Nik is knowledgeable in estimating, documentation control, construction scheduling and processes, contract administration, and financial analysis. Prior to joining Hughes Marino, Nik worked for Bechtel International on the Khalifa Port and Industrial Zone in Taweelah, United Arab Emirates, where he monitored and oversaw the daily construction activities and progress of 5,000 field workers in 53 buildings within the Industrial Zone borders.
Dave Bates, Vice President of Hughes Marino CM, has more than 20 years of construction and project management experience in San Diego. He has overseen the construction of several million square feet of projects ranging from typical office space and specialty tenant improvement projects to large-scale new building construction. Dave is LEED accredited and OSHA 30 qualified, and has been named one of San Diego's top project managers several times over the course of his career.
Travis Carter, a San Diego native, serves as vice president of Hughes Marino. A licensed real estate broker, Travis specializes in representing legal and accounting firms throughout the UTC, Del Mar Heights, Mission Valley and Downtown markets. Travis, a graduate of Point Loma Nazarene University, was honored as one of SD Metro's 40 under 40 recipients in 2011.
Brendan Foote is senior vice president of Tax Credit Services for Hughes Marino, which focuses on securing tax refunds and savings for California businesses who are eligible for various economic development programs. With an expertise in such programs as the California Enterprise Zone Program, the Federal Empowerment Zone Program and the LAMBRA Program, Brendan and his team generate substantial tax savings for businesses located in these incentive zones. Brendan is an active member of the Downtown San Diego Partnership and a board member of the East Village Association.
Kirt Gilliland, division president of Hughes Marino CM, has over 25 years of construction and project management experience in San Diego, having managed over 6 million square feet of projects valued in excess of $400 million. Among the most notable projects are a 23 story, $70 million affordable housing project at 10th and B Street, and the nationally-recognized, award-winning 45,000 square foot New Children’s Museum.
Scot Ginsburg has been solely focused on exclusively representing tenants and occupiers of commercial space throughout his career. With over 8,000,000 square feet of experience, Scot specializes in high-tech, life science, business service, research and development, and other growth-oriented companies. Scot is a guest columnist for California Real Estate Journal and the San Diego Daily Transcript.
Steven Gorup is project manager/LEED AP BD+C for Hughes Marino CM, which is essential for green-building technology implementation. In 2009, Steven obtained the Lean Six Sigma Green Belt Certificate, a strategy designed to improve quality while simultaneously eliminating cost and administrative excess. Prior to serving as a project engineer on University of San Diego’s LEED Silver-certified, award-winning Student Life Pavilion, Steven earned a degree in Construction Science and Management from Kansas State University.
Shay Hughes, chief operating officer, plays a key role in all aspects of the organization, including internal operations, marketing, business strategy, and end-to-end management. A San Diego native, her versatile skills range from designing Hughes Marino’s corporate headquarters, managing the day-to-day operations of the firm, and a strong understanding of the local marketplace and client needs.
Star Hughes is a director at Hughes Marino, the largest tenant representation company in San Diego. A San Diego native, Star specializes in downtown San Diego real estate. Star earned her Masters of Business Administration at University of San Diego, where she was the first and youngest full-time MBA student to complete the two-year program in one year, at the age of twenty-one. Star graduated from University of San Diego with her Bachelor of Business Administration at the age of nineteen after completing her undergraduate degree in two years with a 4.0 overall GPA and highest academic average in the graduating class.
Tucker Hughes is a director at Hughes Marino where he specializes in tenant representation throughout San Diego. A native San Diegan, Tucker is a member of one of the most experienced and respected commercial real estate teams in San Diego, contributing to his ability to provide the best service to his clients. Tucker graduated from the University of San Diego magna cum laude with his Bachelor of Business Administration and is currently pursuing his Master of Science in Real Estate also from the University of San Diego.
John Jarvis is senior vice president of Hughes Marino, a past contributor to Smart Business San Diego, and a leader in countless local charitable, professional and civic organizations. A member of Biocom, International Facility Management Association, and Corporate Finance Council, as well as a graduate of LEAD San Diego, John has earned the trust of a loyal clientele by consistently providing thoughtful and creative solutions on high value real estate projects.
Craig Knox is senior vice president of Hughes Marino, where he is an insightful advisor and aggressive advocate for tenants, especially those in the life sciences and technology sectors where his technical background is a key asset. A graduate of Stanford’s M.B.A. and Master of Engineering programs, Craig serves as a board member of the San Diego Venture Group, a chair of CommNexus’ Capital Markets Committee, and is in charge of real estate for the EvoNexus start-up incubator.
Ashley Lewis, marketing director, is responsible for brand development and marketing strategy for Hughes Marino. As a graphic designer she creates original marketing pieces and advertisements, in addition to writing for the Hughes Marino blog. Prior to joining Hughes Marino, Ashley ran her own graphic design business, specializing in brand identity, print design, web design and illustration. In a previous life, Ashley was an engineer and naval officer who served on San Diego based ships USS Nimitz (CVN-68) and USS Jarrett (FFG-33).
Ryan McCrary, general counsel and vice president of Hughes Marino, is a licensed California real estate broker, a member of the State bar of California, the Association of Corporate Counsel, and the San Diego County Bar Association. Ryan holds an engineering degree, a Master of Law (LL.M.) in real property development, a J.D. from Thomas Jefferson School of Law, and is also a LEED for New Construction Accredited Professional.
Ed Muna is senior vice president of Lease Audit Services, providing tenants with a resource to review and audit their landlord charges, ensuring fairness and proper billing by landlords for operating expenses, CAM charges, and property tax expenses. A twenty year veteran of San Diego’s commercial real estate industry, Ed brings a unique perspective having worked as an owner’s representative, asset manager, and property manager in the development, leasing, management and operations of several million square feet. He is currently involved in the Downtown San Diego Partnership and North County Chamber of Commerce.
Dean Petersen, senior vice president and LEED AP, has been responsible for the management of over 5 million square feet of construction valued in excess of $225 million throughout his 30 years of construction and project management experience. Having directed a wide range of projects, from ground up historical building remodels, multi-million dollar tenant improvement projects, award-winning residential work/live highrises, hospital facilities, airport terminals and universities, Dean brings a strong knowledge of project cost estimating and control, scheduling, quality control, contract administration, and construction means and methods to his clients.
Shane Poppen is a native Southern Californian who specializes in tenant representation in the suburban markets of San Diego County, partnering with companies to make the most of their real estate decisions. His experience includes site selection, strategic planning and needs assessment, financial analysis, negotiation and transaction structuring for lease renewals, relocations and renegotiations. Shane brings persistence, a strong work ethic, dependability, and a results-driven attitude to the Hughes Marino team.
Daniel Turek is an associate of Hughes Marino’s Tax Credit Services (TCS) division. Hughes Marino TCS is focused on securing tax refunds and savings for California businesses that are eligible for various economic development programs. With an expertise in such programs such as the California Enterprise Zone Program, the Federal Empowerment Zone Program, and the LAMBRA Program, Daniel and his team are able to generate substantial tax savings for businesses and business owners located in these incentive zones. Hughes Marino TCS and real estate services pair to create the most comprehensive location analysis in the market.