Commercial Leases Who really pays?

Tenants and landlords both need to consider “unallocated costs” in real estate leases

by Andrew S. Gabriel

Sooner or later, most Nevada busi­nesses will sign a real estate lease. While the base rent is usually clear, all commercial leases (whether office, re­tail, or industrial) contain other provisions that can lead to uncertain “unallocated costs” that must be borne by either the landlord or tenant. To avoid future dis­putes and to effectively allocate these costs to the responsible party, landlords and tenants should indicate their intent in the lease in clear and unambiguous terms.

CAM Charges

Virtually all leases require the tenant to pay base rent. Plus, whether a “net” lease (where the tenant also pays the landlord’s property taxes, insurance and maintenance expenses) or a “gross” lease (where these landlord expenses are in­cluded in base rent), many leases also per­mit the landlord to pass some of its other costs through to the tenant.

In a multi-tenant project, each tenant typ­ically pays its pro-rata share of the land­lord’s costs “of ownership and operation” of the project. These are often called “Com­mon Area Maintenance” or CAM charges. The term is a misnomer, because landlords often desire to pass through to tenants costs other than maintenance expenses.

All of the landlord’s direct operating costs (such as repairs, landscaping, utili­ties and management fees, as well as maintenance) are commonly included in CAM charges. But, the parties should clearly indicate their intent and agree­ment as to any landlord ownership costs (such as mortgage payments, broker com­missions, legal expenses and executive salaries) which may be allocated to ten­ants as part of, or expressly excluded from, CAM charges.

Repairs vs. Replacements and Capital Improvements

Many leases require the tenant to “maintain and repair” the premises without distinguishing between “repairs” and “replacements.” For example, after some time, an air conditioning unit is too old to be repaired, and must be replaced. While the parties may intend that the ten­ant pay for ongoing repairs, the lease may not clearly indicate their agreement as to the party reasonable for replacements. This may become a disputed issue, partic­ularly near the end of the lease term.

By distinguishing ordinary expenses from capital improvements (with a useful life of more than one year), landlords and tenants may best allocate replacement costs. As a reasonable compromise, the lease terms may require the landlord to make all capital improvements (to the premises and common areas), to amortize their cost over their useful life, and to in­clude in CAM charges only the current monthly amortized amount. This allows the parties to fully allocate the landlord’s costs to those tenants who enjoy the bene­fits of the capital improvements during their lease term.

Compliance With Laws

Many leases require the tenant to “comply with all laws applicable to the premises.” While most tenants assume this type of provision simply prohibits engaging in unlawful activities, it also typi­cally requires them to physically alter the premises if necessary to comply with building, health and safety codes related to their particular or changed use.

For example, a new restaurant tenant may be required to install a special ex­haust/fire system for its stove that a non-restaurant tenant would not need in the same premises. However, most leases do not clearly indicate the party responsible for complying with new or existing laws requiring substantial or structural changes to the premises after the lease term com­mences, regardless of the tenant’s particu­lar use. In a relevant Nevada case, our Supreme Court held the landlord respon­sible for any such work not contemplated by the parties in the lease, unless the duty is clearly assumed by the tenant.

In two California cases (based on as­bestos abatement and seismic upgrading laws applicable to all premises), the court applied a complex six-part test to deter­mine the intent of the parties when the lease is ambiguous.

While not binding in Nevada, the Cali­fornia cases help landlords and tenants understand how a court might analyze the is­sues to allocate the costs of compliance with laws. All of these cases suggest that landlords and tenants are free to contrac­tually allocate these costs in the lease if their intent is clear and unambiguous.

Other Unallocated Costs

There are many other uncertain and un­known costs in most commercial leas­es. Whether landlord or tenant, in an effort to avoid future disputes, business owners should consult with their broker and attor­ney before signing a lease to fully under­stand and better allocate these costs.

Andrew S. Gabriel
Andrew S. Gabriel represents clients in real estate and commercial transactions with McDonald Carano Wilson McCune Bergin Frankovich & Hicks LLP, a Reno and Las Vegas full-service law firm cele­brating its 51st year in 2000.