What Every Tenant & Landlord Should Know About Operating Expense/NNN

So, you are a tenant that just signed an office, retail or industrial lease.  And, as part of that lease, you agreed to pay your share of operating expenses/NNN.  This may be a direct share or just increases over the base year when the lease term began.  This is normal and happens in most commercial leases.

However, what varies is what expenses each landlord includes in their operating expenses/NNN and how they calculate them.  If you don’t negotiate this part of the lease correctly, your financial exposure can be way more than all of the rent you pay over your entire lease term and could even potentially bankrupt you.

One such example has to do with insurance policy deductibles.  Most leases require you as the tenant to pay your share of such a deductible if there ever is a claim.  Sounds reasonable and normal, right?  But what if it’s for an earthquake policy where the deductible is 20% of the entire project value?  This is the normal deductible carried by landlords for this type of insurance policy.  This could cost you tens to hundreds of thousands of dollars because you have to pay your share of this expense.

Here’s an example.  Let’s suppose you lease just 5% of a building.  If the entire project is worth 10 million dollars then the deductible on most earthquake insurance policies will be 20% of that or, in this example, 2 million dollars.  Your share of this is 5% x $2,000,000 = $100,000.  How would you, as the tenant, like to have to pay this amount in a lump sum suddenly after an applicable insurance claim was made by the landlord?  Especially when your rent is only $5,000 per month to begin with?

This is just one of many examples of operating expenses/NNN a tenant is exposed to in most leases.  And most tenants and even landlords don’t really understand this particular issue until it happens and it’s too late.  Stay tuned for my next blog with more examples and even some savvy advice for landlords on my recommendation for how to negotiate the lease in this area and calculate these expenses correctly so you don’t end up losing the tenant at renewal time and/or get into expensive litigation over this matter.

If you are a tenant or landlord and want to find out how to avoid pitfalls related to leasing, buying, or selling, please contact me as I have in depth experience and knowledge in these areas including operating expense/NNN audits related to commercial properties.

Leave a Reply