Many commercial leases contain a “gross-up” provision to amplify the property’s operating expenses to the amount of operating expenses that would be incurred if the building was fully occupied. This provision has the effect of shifting expenses to the tenant when occupancy rates are low. Tenants should carefully scrutinize gross-up provisions to ensure that only operating expenses are subject to the clause and that it is limited in scope.
Operating expenses in a commercial lease include expenses for which the landlord is responsible in connection with the building. This includes the costs of repairing, maintaining, and managing the building. In a commercial lease, tenants usually pay a pro-rata share of the building’s operating expenses. The landlord determines the cost of each tenant’s operating expenses by dividing the operating expenses based on each tenant’s square footage.
What happens if the building is not fully occupied? The landlord typically includes a gross-up clause for this predicament. This authorizes the landlord to restate the operating expenses as if the building was completely occupied for one year. The gross-up only applies to variable costs that fluctuate with occupancy rates such as utilities or cleaning services. Other expenses, such as real estate taxes, are static regardless of occupancy rates and should not be subjected to any gross-up clause.
The gross-up clause addresses one of the significant risks of real estate investment and ownership- fluctuating vacancy rates and uncertain expenses. The provision helps the landlord defray his costs when occupancy rates are below 100% especially in a newly constructed building. Without a gross-up clause, the landlord would wind up paying the portion of operating expenses that is not allocated to tenants in the building.
A gross-up lease can also benefit a tenant in a commercial building by providing certainty in costs and preventing the landlord from adding on additional expenses in the future after occupancy rates rise. Suppose the operating expenses are tied to the base year rent. If the base year expenses are low in a new, minimally-occupied building, then those expenses will rise significantly when the building becomes fully occupied since the tenant is paying a pro-rata share of operating expenses in a fully leased building. With a gross-up lease, the tenant is not subject to a large increase in his share of operating expenses in the future.
The experienced team of attorneys at the Law Offices of Mark Weinstein, P.C. can help you litigate your real estate claims. Contact Mark Weinstein and his colleagues at (770) 888-7707 or visit them at https://www.markweinsteinlaw.com to find out how they can advise you.