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.
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.