In today's competitive real estate market where the cost of utilities and infrastructure use are always rising, shopping centers (whether mall or strip), industrial and office building leases frequently require that the tenant pay all or some portion of the landlord's operating expenses to maintain the center in good operating condition. That is according to Dina Tecimer, a partner in the real estate and land use practice group at Manatt, Phelps & Phillips LLP. She, along with Tom Muller, a partner in the same group in the L.A. office, say in the exclusive commentary below that landlords usually prepare the proposed lease, frequently on one of the standard forms with an addendum attached containing the more deal specific business terms. “The landlord prepared lease will include broad language encompassing 'operating expenses” which, more often than not, will include real estate taxes and insurance.”

The views expressed below are the author's own.

The tenant can protect itself by seeking a general caveat added to all leases – that an expense can only be those reasonably necessary to maintain the project in 'safe, clean and good operating condition.  Second, an informed tenant will seek an audit right of the landlord's books and records with a negotiation revolving around the cost of such audit.  Rarely is this audit right used but the risk of an audit frequently deters sharp landlord practices.

Finally, a wise tenant will seek to exclude some of the following items in particular, the success of which will be determined by market conditions, the square footage of the lease, the lease term and the financial strength of the tenant:

• Depreciation and amortization of debt;
• Interest on mortgage payments or ground lease payments;
• Leasing costs incurred when procuring a new tenant such as broker's commissions, advertising, attorney's fees, tenant improvements or other renovations or architectural expenses;
• Costs reimbursable by other tenants as a result of specific provisions contained in such 3^rd party tenant's lease (i.e parking, excessive use of utilities and the like;
• Enforcement costs in pursuing a defaulting tenant such as court costs, adverse judgments or attorney's fees;
• Costs for capital improvements and replacements;
• Overhead and profit paid to subsidiaries or affiliates of the landlord for management services unless such amounts would have been paid had the services and materials  provided by unaffiliated parties on a competitive basis;
• Repairs and maintenance performed in a tenant's exclusive space and not in the common areas
• Penalties or costs incurred due to violations by the landlord of any of the terms or conditions of the leases in the building/center;
• The cost of correcting any code violations that occurred rior to the commencement of the term of the lease;
• Increase in real property taxes resulting from a change in ownership, new construction or reassessment (obviously the big ticket item);
• Wages, salaries or other compensation paid to any executive employees above the grade of building manager;
• Costs for sculptures, paintings or other art objects;
• Negotiate a cap on management fees;
• Costs attributable to repairing items that are covered by warranties; and
• Costs resulting from casualty for which Landlord is reimbursed by any insurance policy.

A tenant must be protected against an inefficient landlord.  Even if the tenant has the right to the above exclusions and the right to inspect the books and records (and/or an audit right), a wise tenant will nonetheless try to negotiate a cap on tenants share of operating expenses.

In today's competitive real estate market where the cost of utilities and infrastructure use are always rising, shopping centers (whether mall or strip), industrial and office building leases frequently require that the tenant pay all or some portion of the landlord's operating expenses to maintain the center in good operating condition. That is according to Dina Tecimer, a partner in the real estate and land use practice group at Manatt, Phelps & Phillips LLP. She, along with Tom Muller, a partner in the same group in the L.A. office, say in the exclusive commentary below that landlords usually prepare the proposed lease, frequently on one of the standard forms with an addendum attached containing the more deal specific business terms. “The landlord prepared lease will include broad language encompassing 'operating expenses” which, more often than not, will include real estate taxes and insurance.”

The views expressed below are the author's own.

The tenant can protect itself by seeking a general caveat added to all leases – that an expense can only be those reasonably necessary to maintain the project in 'safe, clean and good operating condition.  Second, an informed tenant will seek an audit right of the landlord's books and records with a negotiation revolving around the cost of such audit.  Rarely is this audit right used but the risk of an audit frequently deters sharp landlord practices.

Finally, a wise tenant will seek to exclude some of the following items in particular, the success of which will be determined by market conditions, the square footage of the lease, the lease term and the financial strength of the tenant:

• Depreciation and amortization of debt;
• Interest on mortgage payments or ground lease payments;
• Leasing costs incurred when procuring a new tenant such as broker's commissions, advertising, attorney's fees, tenant improvements or other renovations or architectural expenses;
• Costs reimbursable by other tenants as a result of specific provisions contained in such 3^rd party tenant's lease (i.e parking, excessive use of utilities and the like;
• Enforcement costs in pursuing a defaulting tenant such as court costs, adverse judgments or attorney's fees;
• Costs for capital improvements and replacements;
• Overhead and profit paid to subsidiaries or affiliates of the landlord for management services unless such amounts would have been paid had the services and materials  provided by unaffiliated parties on a competitive basis;
• Repairs and maintenance performed in a tenant's exclusive space and not in the common areas
• Penalties or costs incurred due to violations by the landlord of any of the terms or conditions of the leases in the building/center;
• The cost of correcting any code violations that occurred rior to the commencement of the term of the lease;
• Increase in real property taxes resulting from a change in ownership, new construction or reassessment (obviously the big ticket item);
• Wages, salaries or other compensation paid to any executive employees above the grade of building manager;
• Costs for sculptures, paintings or other art objects;
• Negotiate a cap on management fees;
• Costs attributable to repairing items that are covered by warranties; and
• Costs resulting from casualty for which Landlord is reimbursed by any insurance policy.

A tenant must be protected against an inefficient landlord.  Even if the tenant has the right to the above exclusions and the right to inspect the books and records (and/or an audit right), a wise tenant will nonetheless try to negotiate a cap on tenants share of operating expenses.