For the first time in half a decade, Operating Expenses are on the decline.

Operating Expenses are the costs required to operate a building such as property taxes, insurance, common area maintenance, landscaping and repairs, which are incurred by the landlord but ultimately passed through to the tenants. Given the overall economic softening in Houston and nationally, we expect Operating Expenses in Houston office properties to fall by 5-10% in 2021.

Great news for tenants, right? It depends…

Generally speaking, there are two types of commercial lease structures, Net and Gross. Under a Net lease, the tenant is responsible for its proportionate share of Operating Expenses in addition to the Net Rent (also referred to as Base Rent) stated in the lease. So, if Operating Expenses increase, the additional cost is passed through directly to the tenant. If Operating Expenses decrease, the tenant enjoys the benefit of a lower monthly invoice from the landlord.

Under a Gross lease, the tenant’s monthly payment includes one lump sum for “Rent,” from which the landlord pays the Operating Expenses. If Operating Expenses increase during the lease term beyond a predetermined amount known as the “Expense Stop,” the tenant is responsible for such increases in addition to the Rent. If Operating Expenses fall below the Expense Stop; however, there is no financial benefit to the tenant and the monthly Rent expense remains the same.

As a result, establishing the right Expense Stop is critical for tenants operating under a Gross lease. Typically, Operating Expenses during the tenant’s first year of the lease become the Expense Stop for the duration of the lease term. However, in a declining Operating Expense environment this approach could create more cost exposure for the tenant when Operating Expenses start to rise again in the future, as they likely will over the course of a 3-10 year lease term. So the question becomes…how do you avoid setting an artificially low Expense Stop?

Negotiating the best possible Operating Expense provisions within a lease document is critical to mitigating future expense and risk throughout the lease term. Fritsche Anderson is a leading tenant representation firm in Houston, and we strategically negotiate these provisions every day to the benefit of our tenant clients. Contact us today for more information.