Passthroughs: How to Minimize Surprise Costs and Operating Expense Fluctuation

No one likes the unforeseen, unbudgeted costs resulting from operating expense passthroughs.   If you have a Net Lease (most Ottawa Leases are Net Leases), you have, at some point, received an invoice at the beginning of the year for your proportionate share of the operating expense shortfall from the year past, and/or notification of operating expense increases for the coming year.  Typically, the shortfall, or increase of operating expenses, is a modest amount and results in a relatively minor expense.  Unfortunately, this is not always the case, and tenants can receive a nasty surprise.

The reason these passthroughs exist is that it is easier than trying to project variable costs (utilities, maintenance and repair, janitorial, snow removal etc.) with absolute certainty.  As such, a Net lease allows a landlord to minimize their exposure should variable costs increase over time.  This means they can send an invoice at the end of a calendar year to reconcile their books, and/or increase the additional rent the following year to cover rising variable costs.  It seems logical, but it certainly doesn’t help you budget with clarity.

Many tenants’ I speak with think that a Gross Lease, or a full service lease, where both the Net and Additional rent is aggregated into a pre-determined number, is a good way to avoid these unanticipated costs; the challenge being that there are very few landlords that enter gross leases with their tenants.  Further, they are not going to change the accounting for a multitenant building to satisfy one tenant just because they force the issue.

So in a City of Net Leases, how can a tenant be sure that the operating expenses and passthroughs are fair?  Aside from staying away from dishonest landlords, make sure that you have the right to audit.  This right (not obligation) will allow you to audit the operating records for the building and ensure that you are only being charged for items included in your lease.   Typically, the right to audit is given within a pre-determined timeframe, and when expense fluctuations exceed a reasonable amount.  All of this, of course, is negotiated during the offer stage, and prior to signing the lease.

If you would like more information on operating expenses, passthroughs, or audit rights, please contact me at your convenience.

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