A large source of landlord and tenant conflict stems from the Operating Costs clause; a critical clause that is used to determine how much Additional Rent is charged to the tenant. This clause is brutal to read and causes confusion. The common solution: ignore it and hope for the best! The problem: if you don’t deal with the confusion you are guaranteed mismanaged expectations, conflict and exploitation.
Is this legal?
I recently received a call from Ms. D, a sharp business woman. She was certain her landlord charged her an illegal $50,000 increase in additional rent. “This is unfair and therefore clearly illegal!” Ms. D then justified her reaction: “I wasn’t warned that such an increase would occur, the previous year’s additional rent was less and it was a huge increase.” Unfortunately, Ms. D had to learn the hard way: what is legal has nothing to do with what is fair and signing before understanding what you’re signing is foolish.
What should I know?
Read on for a high level cheat-sheet that helps you manage the confusion and avoid a nasty and seemingly illegal Additional Rent hike.
What to add?
- Always include the words “without duplication”. Base Rent is where the landlord makes a profit. Additional Rent (or TMI, Operating Costs), on the other hand, is only used to reimburse the landlord for the costs it incurs to run a building. It should never be used as another source of revenue. Some landlords, however, violate this rule by intentionally making the Operating Clause confusing. The solution: insert wording that prohibits the landlord from being able to “duplicate” fees (that is, add factious fees on top of real costs to produce a profit) and, therefore, make a profit. If the landlord refuses to put in writing that it will not make up fees that create a windfall for the landlord, get nervous.
- Your right to audit: A tenant should always have the right to challenge and inspect the landlord’s operating statement and ensure that no “fake fees” are being charged. Be sure to include a detailed list of what information must be on the statement and who must prepare the statement. Furthermore, add in timelines. For example, request that the landlord produce the statement 10 business days after the tenant makes the request. The landlord should also reimburse the tenant for any overpayments and for the costs the tenant incurred to inspect the landlord’s operating costs.
- All risks insurance: It’s common for building insurance to be part of the operating cost definition. The issue, however, has to do with the type of coverage. It’s prudent for the tenant to require that the landlord carry “all risks” versus only “fire insurance”, as the former is much broader and offers the tenant more protection from potential costs in case of a calamity.
- Excluding tax inputs: The tenant is typically responsible for any HST that the landlord must pay due to its acquisition of services and goods to operate the building. The tenant, however, should require that any HST for which the landlord gets a tax input must be excluded from the operating costs. This is because the landlord is already making this money back!
What to define?
- Define any reference to costs for “permits”, “administrative fees”, “compliance”, “market research”, “management” and “marketing fees”. The tenant shouldn’t be paying for permits unrelated to running the building or for marketing costs associated with leasing a space to a new tenant. What happens if the “permits” or “market research” relate to an expensive expansion or redevelopment project that only makes the landlord richer? The tenant may be stuck with an enormous bill and may be inconvenienced by the whole process.
- How are fees charged? If a management fee is legitimate, ensure that it’s calculated only on top of operating costs and not on top of realty taxes or costs incurred for carrying out capital improvements.
- What programs? Landlords frequently list “all costs associated with any service program established by landlord or required by authorities.” What programs is the landlord planning and who are the authorities? If the landlord can’t answer, ensure that you insert language requiring the landlord to “act reasonably”.
What to strike out?
- Commissions are a cost of doing business; a cost that is already recouped in the Base Rent.
- Capital costs or replacement of anything related to the structure or HVAC systems of the building, unless those costs are amortized over a significant period of time: It’s prudent for a tenant to attempt to cap any increases in Additional Rent if the property is likely due for an overhaul. Tenants may also limit capital costs to items that reduce operating costs, such as replacing outdated electrical systems with “energy friendly” ones.
- Costs for any tenant improvements: The landlord already recoups this cost in Base Rent. If this is added into the operating costs, then the landlord is clearly defining operating costs broad enough so that it may use Additional Rent.
- Costs for marketing property for other tenants: Again, this is already baked into the Base Rent and has nothing to do with managing or operating the business. The landlord may argue that marketing the property is critical to managing the building. This is a grey area.
- Investigating, testing, monitoring, controlling, removing and disclosing hazardous substances: The landlord should have done its due diligence when buying the building and if there is an issue, this is the responsibility of the landlord, not the tenant.
- Fair Market Rental Value for Landlord’s Space: The landlord may try to charge you rent for the landlord’s use of a room in the building or for un-rentable rooms such as electrical closets or janitorial closets. This is a bit much as the tenant’s rent is already being charged on “grossed up” space that forces the tenant to already pay for shared or unusable space. If the landlord can’t rent a space – tough! That’s the price of doing business.
While the above list is the tip of a much larger iceberg, it challenges the idea that ignorance is bliss. It’s not. It’s expensive.
(Article By N. Falcomer)