Denver Business Journal, July 25, 2003

Today’s office lease’s origin comes from old English law

The purpose of the office lease is to define the relationship between a Tenant and the Owner of an office building by resolving to mutual satisfaction the conflicting needs of both parties. The modern office lease had a dignified origin. An illustrious old English law, the Statute of Frauds, required that agreements between a Landlord and Tenant for a term of 1 year or greater must be in writing and signed by the individual or company to be charged.

The modern lease is more than a contract whose terms and conditions are interdependent. Today, Lease provisions are independent of one another. If one party defaults in one part of the Lease this does not allow the other party to take an action to offset the default. In other words, unless it is specified in writing, the Tenant cannot withhold rent if a Landlord fails to provide one of the services agreed to in the lease.

In today’s office building it is expected that the Landlord will provide a continuous flow of services to the Tenant which will include air conditioning, light, water, restrooms, elevator service, janitorial services, security and access through the common areas. Tenants can expect certain services from the Landlord and there will be remedies provided in the lease if the Landlord fails to provide these services.

Two Types of Leases

There are two basic types of leases today. These are known respectively as a Gross, or Full Service Lease and a Net Lease. These two kinds of Leases are identified by the way that the services provided in the building are computed and paid. In Colorado, rental rates are quoted as per square foot per year. Thus, as an example, a rental rate for 3,000 square feet based upon a full service contract or Gross Lease will be quoted as $19.00 per square foot per year or $57,000 per year (a $4,750.00 per month installment). In a Net Lease the basic rent is quoted on a per square foot per year basis with the additional costs billed separately.

Understanding Triple Net

Depending on the provisions of a new lease, the Tenant may be asked to pay for some or all of the services of the building in addition to a rental rate for use of the demised premises. If the Tenant pays for real property taxes only, he has signed a net lease. However, if the Tenant agrees to pay for repair and maintence costs in addition to real property taxes and insurance he has signed a “triple net” lease.

In all these cases, the Tenant is billed separately for the cost of services agreed to in the lease, in addition to the base rental rate. For example, in a true triple net lease the Tenant may have negotiated a rental rate of 15.00 per square foot per year. In addition the Tenant will be billed for other expenses which in some cases can amount to an added $5.00 to $6.00 per square foot per year. This type of lease is used more often in the small, older buildings found outside the central business district or in industrial facilities.

It is especially important when considering a new lease to understand that costs to be paid for by the Tenant include all building expenses unless this is negotiated and the costs are specifically itemized. For example, when a Tenant assumes the payment for “all maintenance costs” he or she must understand that this can include repair for a caved in floor, a flooded basement due to a burst pipe, or repair to a roof.

The Full Service Approach

Under a full service lease the Tenant pays a base rent which is for the first year of occupancy. The owner pays all the expenses involved in providing the services to the building.

In the modern office building, the cost of operating the building or services are estimated and adjusted to reflect any increases at the end of each year after the base year or first year of occupancy. These escalations are passed through to the Tenant. For example, a Tenant leases a 3,000 square foot office in 1998, the base year, in Building A for $20.00 per square foot per year full service or Gross. The space is 2.5% of the total building square footage. The cost of services in Building A for 1998 was estimated to be $600,000. Let’s assume that the actual cost of services for 1998 was determined at the end of the year to be $750,000. The Tenant would then be billed the difference between the estimated expenses and the actual expenses based on his prorata share. In this case the actual dollar amount to be paid would be 2.5% of $150,000 or $3,750.00.

In Building B, which might be a more inefficient facility, the Tenant’s pro rata share might be 5% and the actual operating expense increased by a higher dollar amount. This would result in a higher rent to the Tenant. It would be important to know and understand these differences between buildings A & B.

The Capital Improvement Clause

In addition to the operating expense pass through, a Tenant may be asked to pay for capital improvements to the structure. These expenses are necessary to maintain the various systems in the building and often result in controlling operating expenses. For example a new roof would be an essential capital improvement whereas a Tenant might argue whether replacing the common area carpeting with marble is necessary for the continued functioning of the building.

Especially in these tighter economic times, understanding the type of lease being negotiated and how the rent is to be paid is an important economic consideration for any Tenant.

Paulette Wray, principal of Wray & Associates, a Denver-based tenant representation firm, has 18 years of commercial real estate experience.
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