Tenant Build-out And Operating Expense Lease Provisions Can Pose Problems For Landlords
Landlords of commercial property must be careful in preparing and signing leases. This is especially true of landlords of large multi-tenant facilities, where form leases are likely used. One poorly-drafted provision can have recurring implications, particularly when utilized with multiple tenants. Although every commercial lease is unique, there are three provisions that are often problematic for landlords of large commercial facilities: build-out and operating expense provisions, eviction and repossession provisions, and repair provisions.
Getting the Tenant In: Build-Out and Operating Expense Issues
Many commercial landlords offer “turn-key” construction of leased commercial premises, which means that the landlord agrees to provide and perform certain specified work, with anything beyond that work at the tenant’s expense. Most commercial office building leases are “turn-key,” while many retail and industrial leases provide for the work to be performed by the tenant.
In situations where the landlord is responsible for the build-out of the space, tenants typically try to get the landlord to perform as much work as possible, and to provide some type of warranty for the work that the landlord performs. Tenants are also usually concerned with the completion date of the work (which often triggers the commencement date of the lease), because they want to begin operating as soon as possible. Given the uncertain nature of construction, however, landlords should be careful when negotiating these types of provisions.
Ideally, the landlord should attempt to include a clause in the lease providing that the commencement date of the lease can be extended without penalty to the landlord for as long as it takes for the landlord to complete the build-out of the space. Landlords should also consider including a provision that protects them from claims made by the tenant related to defects or delays in the construction. These provisions usually also provide that the tenant’s acceptance of possession of the premises is deemed acceptance of the premises, and operates as a waiver of any claims against the landlord related to construction defects or delays.
Most commercial leases also provide that the costs of operating in the premises (such as common area maintenance charges, taxes and insurance) are passed through to the tenant for payment. For example, in office building leases, it is rare to have separate utility metering for each tenant, so utilities are typically included in this pass-through of costs.
From the landlord’s perspective, “operating expenses” should be defined as broadly as possible. Tenants will often try to be specific and narrowly define terms, negotiate for certain exclusions, etc. Tenants also often seek to add a provision to the lease that contains audit rights, meaning that the tenant has the right to review and challenge the landlord’s operating expense calculations. Although audit rights are common in most commercial leases, landlords should avoid them if at all possible. These provisions have the potential to become an administrative nightmare if the landlord has to deal with the hassle of proving its operating expense calculations and breakdowns to any unsatisfied tenant.
Landlords should also consider including what is commonly referred to as a “gross up” clause in the lease. This type of provision allows a landlord to calculate operating expenses as if the building were fully occupied even though the building may, in fact, not be fully leased. Only operating costs that vary by occupancy rates should be included in this type of provision, which may be such charges as electricity, utilities, trash removal, management fees or janitorial services. These provisions are beneficial to landlords because they shift some of the responsibilities associated with vacancies to the property’s tenants.