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Capital Expenses, Laws and Cost Savings

When I saw a piece captioned "Building Owners Toss Equipment for New Technology" it reminded me of a lease I negotiated recently.

When negotiating a net lease, tenants will often request that a building's operating expenses will not include capital expenditures.  That makes sense.  But when I am representing the landlord and that is the business deal, I try to add two carveouts. 

The first is legal compliance costs. If you are saying, "Huh?" let me explain.  Say a new law comes into effect after the lease is signed requiring landlord to install a widget in the building and that widget costs $25,000.  While that is a capital expenditure, it was something that has to be installed to keep the building in compliance with the new code.  That in my humble opinion is an expense that can be amortized as a non-capital expense.  Now, if the code had already existed and the landlord just failed to comply -- that is a different story and should not generally be on the tenant's nickel.

The other cap ex that I think needs to be carved out is one that achieves actual cost savings.  There is a sound reason for this in my opinion because it helps encourage such savings.  Let's say a landlord opts to replace the old (but still working) HVAC system with a new, highly efficient one that costs $200,000 and will last twenty years.  (For simplicity we'll amortize it in a straight line without interest at $10K a year.)  If the new system saves $10K or more a year, then I think that cost should be passed through to the tenant. Why?  Because the tenant is in no worse position than if the system had not been installed at all, and it will be less likely to have an HVAC failure with a new system than an old, creaky one. And if the savings exceed $10K, then the tenant will still realize savings. 

But what if the savings are only $5,000?  I think the tenant has a strong argument that only the $5,000 should be passed through.  The point is to put tenant in the same position it would have been, and I think that is usually fair.  (There is always an exception to everything, from my experience.)

In any event, this just one of many, many issues that come up in commercial leases.  I find that a good balance between the landlord and tenant's needs will often get the job done, and in a fair and efficient manner to boot.  Yeah, that cuts down a little on my fees if I am billing at an hourly rate, but it just gets us to where we'd almost always end up anyway in the negotiation.