“Grossing Up” Operating Expenses a reasonable concept that gets lost in translation

In the operating expense provisions of an office lease you may come across wording that allows the landlord to “gross up operating costs which vary with the use and occupancy of the rentable premises in the Centre as if the property were 97% occupied and operational.”

These costs are generally cleaning, waste removal, utilities and management fees if based on a % of operating costs. Leases allow these costs to be grossed up to a range of 95% to 100% occupancy.

On the surface, allowing the landlord to charge for more expense than they incur seems absurd. However, the concept is fair to the landlord – yes, you read that right – and fair to the tenant.

An extreme example to illustrate the point:
Assume there are two tenants in a 100,000 sq. ft. office building, Tenant A and Tenant B, who occupy 50% of the space each. The cleaning costs are $1 per sq. ft. per anum, or $100,000. Cleaning contracts allow vacancy credits to be given to the landlord if tenant(s) vacate the premises.

Now let’s say Tenant B vacates the premises for a full year, reducing cleaning costs to $50,000. Without a gross up, Tenant A would now pay 50% of $50,000, equaling $25,000, even though they are responsible for 100% of the cost. The landlord would be out of pocket $25,000. Grossing up the cleaning expense to 100% allows the landlord to recover all of its costs.

Lost in translational
Where this concept often breaks down is in the calculations used by landlord administrative staff. We have seen situations where incorrect calculations have resulted in tenants paying more on those variable expense items than if the Centre were 100% occupied.

For example, occupancy has no bearing on labour or utilities for the lobby, elevators, outside areas, or other common areas. Even vacant leaseable premises require a minimum of heat in the winter.

A Colliers audit on a 7,000 s.f. office space in Ottawa netted a $32,000 recovery for our client. The landlord had applied gross up calculations to the utilities on vacant space. However, they had continued to cool, heat and light the vacant premises as though they were fully occupied in order to make the marketing and showing of the space more appealing.

Finally, vacant space rarely remains so for a full year and appropriate calculations are required to ensure the gross up is applied only to the time the space was vacant.

REMEDY

Have the ‘right to audit’ written into the lease agreement in order to ensure that the grossing up is done correctly. Clear, concise lease language such as the following is also essential:
“The landlord is entitled to gross up those items of operating costs which vary with the use and occupancy of the rentable premises in the Centre as if the Centre were (% rate to be negotiated) occupied and operational. For greater certainty the variable costs are cleaning and utilities. In no event shall the tenant’s proportionate share of the variable expenses be greater that would be payable if the property had been fully rented.”

c/o Frank Iannarilli – Colliers International