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A History of Leases- How Are Landlords Shifting All Costs To The Tenant?

November 7, 2017

Where’s Marty McFly (Back to the Future) when you need him? How about going back to the days of yesteryear, wait, wrong movie. Either Marty or the Lone Ranger might be asking the same question, “Why does my rent go up in two ways every year?” The Lease says it increases by a certain percentage or fixed amount each year but then the Landlord also sends me another bill for something called Building Operating Expenses.

 

Here is a bit of leasing history. Feel free to add or question or as we say in today’s world, “FactCheck.”

 

My father-in-law used to share stories of his days as a commercial real estate broker in the early 1950’s. He was the top agent for Helmsey-Spears and Company in New York City. He would rent a loft for $5 per year flat fee for the term. The lease was referred to as a Full Service Gross Lease. On a five-year lease, the landlord would calculate what his total costs would be during the term considering all his expenses including marketing, mortgages, taxes, general maintenance, and utilities. The rental rate would easily cover all his costs for the first few years. If the operating expenses possibly increased above the rental income during the last year or so, profits received early on would be balanced against any later shortfalls.

 

As inflation numbers fluctuated, the idea of a “Step Lease” came into vogue. To cover the unpredictable increases in operating expenses the Step Lease allowed landlords to increase the rent tied to an inflation rate, typically, the Consumer Price Index. Often it contained a base and cap of 2% to 6%.” Since the building was appraised based on the last year’s values of each individual lease in the building the landlord covered his cost and got a fixed higher appraised value.

 

As inflation hit 17% to20% even the Step Rents couldn’t keep up with the operating costs and no tenant would sign a lease that had a 20% cap on expenses. In comes the “Base Year” concept.  

 

Using a Base Year, the operating expenses during year one of the lease are included in the base rent. However, if those expenses increase in year two or beyond, the tenant pays their pro-rata share of that increase based on the percentage of the building they occupy. Advantage-- Landlord.

 

But wait, now landlords are still increasing rents by a fixed amount and getting paid for all their increases in operating expenses. Can anyone say, “Double Dipping?”

 

Will we ever see fairness again? It seems unlikely. Ideally a landlord should offer a flat rate for the term and the tenant should pay their pro-rata share of operating expense increases. Or the other option would be that the rent would go up by a fixed or preset variable as before the creation of Base Years to cover potential expense increases and thus eliminating the Base Year concept.

 

According to Terry Barger, Managing Principal or Cyberlease, one of the nation’s leading authorities on Building Operating Expenses:

 

Some 45 years ago, the leasehold estates defined in commercial office leases in the United States generally produced a ‘fair trade’ between landlord and tenant. For the landlord, its ownership rights allowed it to lease a property and benefit from rent, while it retained the financial risks of having those ownership rights. For the tenant, its lease- hold rights allowed it to use a property, in exchange for the payment of rent, without taking on the risks of owning the property. (Full article)

 

 

Who makes out from this double dipping? Certainly not the tenant. Landlords get advanced increases in the building value as well as recouping all their operating costs.

 

How will your next lease read? Either way, we sure have come a long way from the days when a tenant could pay $5 to rent a loft.

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