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Major Lease Terms and Customs

What You Should Know

Following are some major lease terms and customs which you should know before choosing spaces:

Base Rent
Operating Expense Escalations
Real Estate Taxes
Electricity
Cleaning
HVAC
Loss Factor

Base Rent

In the trade, commercial office leases are referred to as "gross" or "net". In the New York City office market, the vast majority of leases are gross. We include a brief description of both kinds of leases below.

Gross Leases
Gross leases include operating expenses, taxes and an allocation to the landlord to cover its cost and profit for the year in which you sign your lease. Should operating expenses and taxes increase in subsequent years, a landlord may charge you for your pro-rata share of the increases or use some other method for estimating increases.

Gross rent figures are mostly market driven or "what the market will bear". The landlord prices its space to cover its costs (purchase price, mortgage payments, etc.) and its profit. In down markets, landlords may rent at a loss just to have tenants in their property. In tight markets, landlords will push market rates. It is very difficult to estimate a landlord's true profit because a variety of factors will impact it including when the property was purchased, the price paid, the mortgage terms, etc.

Net Leases
Net leases imply that the tenant pays the taxes and operating expenses and pays the landlord only the "profit". It has a variety of derivations including triple net, double net, etc. These variations refer to situations in which tenants pay all the expenses of the property, or just taxes, or just operating. It varies based on the circumstances of each situation.

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Operating Expense Escalations

The concept behind operating expense escalations is that tenants should share on a pro-rata basis the cost of increases in the operating costs of the building.

Direct or Current Operating Expense
The landlord or its managing agent hire the personnel, make management and operating decisions and pay the operating costs of the building throughout the year. The manager will then bill each tenant for its pro-rata increase for each year according to the proportionate share stated in a lease. (i.e. a full floor tenant in a 100,000 square foot building with a lease of 25,000 square feet would have a proportionate share of 25%). Landlords typically will invoice you monthly based on the prior year's actual cost. After year-end, the landlord will provide a reconciliation of actual versus what you were billed. You will be asked to pay any shortage within a certain number of days. If you paid more than the actual, the landlord will likely credit such an amount to your next payment due. All of these terms will be stated in your lease.

Increases at a Fixed Rate or CPI (Consumer Price Index)
Some landlords require this alternative calculation. Instead of calculating increases in operating expenses over a base year, the landlord will require a percentage of the base rent be paid, typically on a compounding basis, over the term of the loan. The percentage may be fixed or based on a variable rate, such as CPI. The amount of money the landlord recovers will likely outpace what it spent on operating costs especially for long term leases.

Porters Wage
This method is based on the porter's wage in the year in which you lease. This billing method originated from the assumption that the increases in cost of running a building is approximately the same as the increases in wages. Therefore, the wage for a porter pursuant to the applicable union contract is used as a base. The porter's wage is determined every three years by agreement between the Realty Board on Labor Relations and the union 32B/32J. Wages are determined separately for commercial and apartment buildings. Similar to an operating expense escalation, the porter's wage concept is based on increases over a base year. The porter's wage for the year in which you execute your lease becomes your base year. Fringes refer to the actual fringe benefits to which porters may be entitled under the union contract.

Porter's wage charges are typically much more costly than operating expense charges because the initial base number is higher than the operating expense base. For example, the 1998 porter's wage is $13 while the average operating expenses per square foot in Midtown for 1998 was approximately $9.

Porters wage can be calculated as a penny base rent increase for every penny increase in wages, and can be up to two pennies for every one penny increase. Pay attention that your lease specifies that actual hours worked by the porters, not hours paid. Do not allow your landlord to recalculate by use of this method.

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Real Estate Taxes

The New York City tax year is fiscal beginning on July 1. Under the auspices of the New York City Department of Finance, city appraisers develop a market value for each office building. Each building is assigned a block and lot and tax assessment and tax liability information is publicly available through the Department of Finance.

Once the city appraiser determines a building's market value, the value is generally multiplied by 40% to arrive at an assessed value. The assessed value is then multiplied by the tax rate for that fiscal year.

The city offers a variety of incentive programs which reduce taxes. These are discussed fully in the Finalize section of our site.

Unlike operating expense calculations, real estate tax escalations are generally calculated using only one method. Escalations are based on increases in taxes over a base year or "stop". The base year for your lease can be based on one of the following:
 

  • the fiscal year in which your lease commencement date falls;
  • the calendar year in which your lease commencement date falls; or
  • a "rolling" base year or following 12 months based on the month in which your lease commencement falls.

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Electricity

The three most common methods for charging for electricity are direct, submetered and rent inclusion

Direct
The simplest and least expensive method is for the tenant to obtain a third party electrical provider (for example, Con Edison). The tenant contracts directly with the provider and pays them. As a rough benchmark, costs per square foot for general office use (no special computer rooms, additional air conditioning equipment, etc.) is in the range of $1.65 to $2.00 per square foot. You are not liable to pay commercial rent occupancy tax if electricity is billed direct.

Submetered
In this case, a meter is installed that measures electrical usage solely from your premises. However, the landlord is the one that contracts with the third party electrical provider, not the tenant. The landlord then bills the tenant the "actual cost" plus an administrative charge. The administration charge can range from 1% to 12%, but after negotiation, typically falls in the middle. The definition of cost can be complicated within the lease clause. Tenants may be liable (depending on the lease) to pay commercial rent occupancy tax on submetered electric.

Rent Inclusion
Electricity charged on a rent inclusion basis is a fixed amount, which is typically quoted on a per square foot basis. (Example: $3.00 per square foot on a 2,000 square foot lease would result in $6,000 per year or $500 per month). It is not directly related to the landlord's actual cost and includes a profit add-on for the landlord. For general office electrical demand (lights, PCs on each desk, etc.), the cost per square foot could be $1.65 to over $2.00 per square foot. Therefore, the landlord has a built in profit. The electricity lease clause will nonetheless typically provide the landlord the right to conduct a lease audit on a periodic basis to determine if usage has increased over certain initial usage levels and may have the option to increase the charge. Additionally, the landlord typically reserves the right to increase the charge if the third party electrical provider increases its rates. Tenants always pay commercial rent occupancy tax on rent inclusion since electricity is classified in the lease as additional rent.

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Cleaning

Cleaning costs are generally included in standard office leases for Class A space in Manhattan. However, the costs vary in Class B office buildings and are not generally included in the base rent of Class C office buildings, loft buildings, industrial, warehouse, and retail space.

For leases that include cost of cleaning, cleaning specifications are attached to the lease document that outline the types of cleaning included and how each task is performed. It is fairly standard that some level of cleaning is performed nightly, such as trash removal. Other tasks, such as dusting desktops and ledges may only be performed weekly.

While a landlord's cost to provide cleaning will vary based on the number of buildings it includes in a particular contract, a rule of thumb for general cleaning is $2 per square foot per year.

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HVAC

To understand HVAC (heating, ventilation and air conditioning) costs, it is important to have a general understanding of the type of HVAC system that will serve your premises. Particularly for companies that require 24 hour/7 day a week service, HVAC can be a substantial cost depending on the type of system. In addition, some companies may have critical HVAC needs, such as temperature control in a computer room. In these cases, special systems may be needed

Your HVAC cost is dependent upon two main factors: (1) who controls the system and (2) the structure of the system.

There are three functional ways that the systems are controlled; five basic system air-conditioning systems and three basic heating systems.

Control


Landlord Controlled (Landlord pays to maintain)

If the landlord both controls and maintains the system, the landlord will state standard hours during which it will provide HVAC. For example, Monday-Friday from 8:00am to 6:00pm and maybe some time on Saturday. If a tenant requires HVAC during other times, it will likely pay an hourly charge, often with a minimum amount of hours. The hourly charges will vary by building but can easily be over $100 to $400 or more per hour.

Tenant Controlled (Tenant pays to maintain)

If the tenant both controls and maintains the system, the tenant can operate the HVAC system during the hours it chooses. However, the cost here depends on the type of system. As described below, if the system operates on chilled water or condenser water, the tenant has to pay for the water, typically on a per ton per annum basis. If the system is air-cooled, then the tenant will typically pay only the additional electrical charges required to run the system.

Landlord Controlled, Tenant Maintained

In some cases, the landlord will control the system and the hours of operation, but require the tenant to pay to maintain the system. Depending on a tenant's negotiating leverage during the lease negotiations, this cost may be able to be put back to the landlord.

Air Conditioning Systems

Central cooling tower with chilled water. (May be divided into building zones)

In this system air is blown over water to chill it. Depending on the size of the building, a system could have several chiller units which are often times housed in the basement of the building. The chilled water is then piped throughout the building to fan rooms. The fan rooms can be on each floor, on particular floors that then serve a zone of floors, or several fan rooms can be on a single floor depending on the size of the floor.

This system offers the least flexibility for the tenant because it is expensive to operate after hours. Another issue is your location within a particular zone. If one chiller serves several floors, one of which is yours, you will have to pay to run the system for several floors. If you are lucky, all other tenants within your zone would choose the same after work schedule and you could split the cost with them, but this is unlikely.

Central cooling with condenser water. (May be divided into building zones)

This system has the same general attributes as a central cooling tower with chilled water except the water is not chilled by cool air being blown over it rather it is cooled by a chemical process. This chilling is done on a floor by floor basis through local air handling units. If the condenser water (basic tap water) is mixed with an anti-freeze like Glycol, it is sometimes called a Glycol system.

Package units. (Using chilled or condensed water)

This type of system typically provides a package unit located within the tenant's premises. The system is run on either chilled water or condenser water which is piped into the package unit. In this case, the unit will have to be operated based on the landlord's stated business hours. If the tenant wants after hours air-conditioning, it will have to pay the landlord's hourly rate or negotiate.

Package units (Air Cooled)

Air-cooled units require proximity to a window to access outside air. The system then cools the air (through a chemical process) and distributes it to a space.

Heat Pumps

This system is composed of air or water cooled units containing compressors, giving off heating and cooling depending on the season. Typically, these are small units located in multiple areas throughout the space, usually under windows.

Heating Systems

Heating systems are generally landlord-controlled. These systems are usually located in the basement. The basic heating system structures are:

Steam Heat

Steam is typically provided by the local utility, such as Con Ed. The steam enters the building in a central location and is piped to each floor. Radiators on each floor then push the hot air into the space through the convection process. Con Ed or a boiler in the building could be the source; be aware that Con Ed is moving away from providing steam and prices are rising.

Hot Water

With this type of system, one or more boilers will be located in the basement of the building. The steam is converted to hot water or hot water is piped through the building within a radiator system that heats through the process of radiation and convection which is then piped throughout the building. Units on each floor then provide the heat to each space.

Heat Pumps

This system is composed of air or water cooled units containing compressors, giving off heating and cooling depending on the season. Typically, these are small units located in multiple areas throughout the space, generally under windows.

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Loss Factor

The loss factor is the amount by which the landlord's rentable square footage for a space relates mathematically to the usable square footage. An example is as follows:

10,000 rentable square feet
20% loss factor =
8,000 usable square feet

Loss factors are determined by the landlord as a result of market driven issues as well as physical issues in the building. Do not expect the dimensions of your space to match the total square feet amount you will be billed for. Although it certainly impacts the amount of rent you pay each month, it is not typically negotiated unless you are a very large tenant in the building.

A common comment we hear when we are touring spaces with tenants is that 5,000 square feet in one building does not feel like 5,000 square feet in another. This can be caused by a significant loss factor in a building or the layout of the space. If the space is on a multi-tenant floor, the loss factor will be higher because of the common hallways, restrooms and other shared elements on the floor. A pro-rata portion of these elements is factored into the loss factor. If the space encompasses an entire floor, the loss factor will be lower because common elements are not required.

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