It’s that time of year again. RCR has been in the midst of reviewing Operating Expense estimates, reconciliations for clients to ensure Landlords are properly adhering to caps and exclusions negotiated in the lease document.
What are Operating Expenses? Operating Expenses include any costs to maintain, repair, and operate a building. This includes the space your company occupies as well as a “pro-rata” share of the common area spaces such as lobbies, restrooms, elevators, and shared conference rooms. Additional expenses can come from other elements such as landscaping, parking lot maintenance, and snow removal.
So far in our review, we have seen Landlords struggle over the prior few years to maintain and consistently control operating expenses. We have also seen an uptick of errors related to cap adherence. With inflation, supply chain, and other pricing pressures, Operating Expenses have been a challenge for even the savviest of real estate operators and managers. Additionally, many buildings have changed ownership in this last economic cycle and often quality historical expense data is not provided to a new owner.
Utilities – Compared to 2021, the cost of utilities are up, especially electricity costs. In 2021, the average cost for electricity per kWh was $0.141. In 2022, we saw the average price per kWh jump to $0.159. Inflation is the primary cause for the increase. HVAC costs also experienced an increase. During the pandemic in 2020 and 2021, many Landlords were less diligent with HVAC maintenance and Tenants were not utilizing it as heavily. Landlords are now experiencing units with deferred maintenance.
Janitorial Services – Janitorial services saw an increase in cost. Supply and labor shortages are the factors contributing to the increase.
Snow Removal – With only a small impact in early 2022 and no threat of winter weather in late 2022 (in Central NC), these costs should be minimal.
Landscaping – Landscaping costs have increased. Similar to Janitorial Services, supply and labor shortages are the factors contributing to the increase.
Taxes – Both Wake (Raleigh, Cary, Apex, Garner, Wake Forest) and Durham Counties have upcoming tax reassessments. The last time the respective counties reassessed was Pre-Pandemic. Though most leases do not place caps on Taxes, the upcoming assessment has a number of implications. Regardless of the location, we all know that taxes generally do not go down….
Insurance – Much like taxes and utility rates, insurance premiums also rose again for the sixth straight year. The average increase in commercial general liability insurance is roughly 7% according to Insurance Business America.
There are a few additional risk factors that RCR is keeping an eye on:
- Additionally, with office vacancies 55% above pre-pandemic levels in most markets, gross-up provisions and base year strategy are significant factors for Tenants.
- Office Landlord defaults are up and with vacancy and interest rate pressures, this will become more impactful to Tenants. Sales, defaults, and receivership all precipitate turnover in the administration, management, and consistency of Operating Expenses. RCR anticipates this issue being a driving factor in failure to adhere to the negotiated lease language.
Please ensure your organization passes any estimates, reconciliation reports, or communication from the Landlord to our team. We will review and compare with your Operating Expense lease language to ensure adherence. Caps are going to be extremely important and come into play this year and next. Should you have any questions, please contact our team.