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Web Articles
                        Examination of Expenses
           Passed Through to Commercial Tenants

Landlords who lease commercial space to tenants under net
leases must be certain that the leases are drafted clearly and
that the terms of the leases are implemented properly or the
landlord risks various consequences including the waiver of
their right to collect certain pass through expenses from tenants.

Under a “gross” commercial lease the tenant pays only their
monthly rental amount, there is no separate contribution by the
tenant to the operational expenses of the commercial real
estate project.  But with a “net” commercial lease, the tenant not
only pays their monthly rental amount but there is another
payment that represents tenant’s contribution to the payment of
agreed upon operational expenses for the project.  

Under the typical net lease structure, the landlord will estimate
the project’s operating costs which the tenants will contribute to,
for the following year.  Then each month the tenants that
contribute to the payment of these operating expenses do so by
paying 1/12th of their share of the estimated operational costs
of the project.  The landlord typically has a right to adjust the
amount of the pass through expenses that the tenants pay
each month if the operational expenses for the project are
higher than estimated or if unanticipated expenses are
incurred.  Then, typically, at the end of the calendar year, the
landlord reconciles the actual expenses incurred during the
year and the pass through contributions collected from the
tenants and if excess contributions were paid by the tenants
then either the excess is refunded to the tenants or the excess
may be retained by the landlord and credited against future
payments.  If the reconciliation reveals that insufficient
contributions were collected from the tenants then the landlord
may be permitted to impose a special assessment on the
tenants to account for the shortfall.

Which expenses are passed through to and paid by the tenants
leasing space within the project under net leases varies
between different leases but there are expenses which are
generally always passed through to tenants.  Landlords
however do incur various expenses related to their projects
which are
not generally passed through to tenants.  What costs
will be passed through to tenants can greatly impact the tenant’
s leasing costs and the landlord’s operating expenses so these
costs are matters which often must be negotiated between the
landlord and the tenant and must be clearly described in the
lease.  

As a means of controlling the impact of pass through expenses
on their leasing costs, a
tenant may request that increases in all
or some of their pass through expenses be limited.  While this is
an issue to be negotiated by the landlord and tenant, there are
certain points which the landlord must weigh when considering
such a request.

Another issue that may be a point of negotiations between the
landlord and the tenant is
management fees.  While many of
the expenses that pass through to and are paid by tenants are
rather straightforward, such as maintenance of a parking lot
that serves all tenants within the project, one expense that may
not be so straightforward is management fees and this can be a
point of contention between the landlord and the tenants.  

But while the specific terms of their lease and which specific
pass through expenses they will pay is the result of the tenant’s
negotiations with the landlord and varies between different
leases, one common point across all net leases is that the
landlord must be
careful in their assessment of expenses to the
tenants or they risk waiving their right to collect certain pass
through expenses from the tenants or possibly fostering
discourse between themselves and the tenants.

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