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Traps in Commercial Leases: Part 1 – Hidden Expenses, Costly Oversights

By Eric Gravink

Recently, I met with a potential client who is a tenant under a fairly typical commercial NNN lease. He received a bill for his share of operating expenses, which had surprisingly more than tripled. The increase was triggered by the landlord’s sale of the property that prompted a reassessment of property taxes, which was passed on to the tenants. Unfortunately for this tenant, the lease was pretty clear – he was on the hook for the increased costs. This scenario plays out far too often in commercial leases, catching tenants unawares, and adversely affecting their bottom lines; thus, I thought it worthy of discussion.

Frequently, tenants – even the savviest business operators – gloss over the importance of lease provisions regarding payment of real property taxes. This is, in part, due to the standardization of many leases and, in part, due to a failure to consider the impact of a reassessment on a tenant’s monetary obligations under the lease. In many instances, tenants neglect to consider the effect potential landlord changes may have on the lease terms.

When negotiating a commercial lease on behalf of a tenant, I invariably ask the client, “what is the current assessed value of the property and what is the current market value of the property?” While Proposition 13 has many advantages for property owners, its impact on tenants who fail to take into consideration a property’s current assessed value can be significant.

In a recently negotiated commercial lease, the property’s assessed value was less than $300,000; however, the market value of the property was well over $2,500,000. In this case, if the landlord sold the property after the lease went into effect (or, if the property was reassessed for some other reason), the real property taxes would increase nearly ten times. On a typical NNN lease wherein the tenant is responsible for all real property taxes, this would equate to a difference of nearly $30,000 per year in increased operating expenses passed on to the tenant(s). In many cases, this increase in expenses could make or break a tenant.

Fortunately, with my client, we identified the large disparity in the assessed value versus the market value of the property during lease negotiations and were able to negotiate a cap on any increase in real property taxes. Unfortunately, most tenants, and many practitioners advising them, fail to consider this until it is too late.

Even when representing a landlord in a lease negotiation, I believe it is helpful to have a similar discussion to prevent surprises down the road and to avoid a potential dispute over the issue, or create a situation where the tenant can no longer afford lease payments and be forced into default.

Commercial leases, while often containing standardized terms, have inherent clauses with somewhat veiled nuances, the long term ramifications of which can be easily unnoticed. “Standard” language in a lease can have far reaching effects that both tenants and landlords should consider before signing on the dotted line.