One important lease provision that any tenant should be aware of is the provision that sets forth various types of “additional rent” the tenant will be responsible for. It goes without saying that tenant’s additional rent payments are important to understand because these types of cash outflows can inherently affect your bottom line. There are a variety of different landlord methods for charging these various costs. Take property taxes for example; some landlords require tenants to pay their “pro rata share” of any increase in taxes over the tax base year, while some landlords require the tenants to pay their pro rata share for the entire tax bill. If the building is of the nature that one tenant occupies the entire building, then it is likely that the tenant will be responsible for the entire tax payment.
As any good lawyer does, it is imperative that the above calculations are defined. What is a pro rata share? A tenant’s pro rata share is the percentage of space it occupies in proportion to the total space of the building. So, if a tenant occupies 1,000 square feet of space in a building that has 10,000 total square feet, the tenant’s pro rata share will be 10%. What is a base year? A base year is used to refer to a set year, often the first year of a lease term, from which the taxes that are charged to the tenant are based on; if the base year is not the first year of the lease term, the tenant should make sure the lease is updated to reflect the proper year. Let’s use the following example to illustrate how this would work out in an actual real life lease negotiation. Say that the base year is the 2020 – 2021 fiscal year, and the total tax for such year is $100, the tenant will only be responsible for its pro rata share of the increase in taxes over the $100 base. A pro rata share of 10% for the 2021-2022 tax bill for the entire building of which the tenant’s premises forms a part will lead the tenant to be responsible for $1 in taxes. Alternatively, if the tenant is responsible for its pro rata share for the entire tax bill, then the tenant would be responsible for $11 in taxes for the 2021-2022 tax year, which, when thinking about real lease numbers, can be a significant difference. If the tenant was the only tenant in the building and was responsible for all of the taxes, the tenant would have to pay the entire $110 tax bill for 2021-2022.
In working out the numbers, a tenant should always try to ensure that it is only responsible for its pro rata share of the increase in taxes over a base year, and to ensure that the base year is, at the earliest, the year in which the lease is executed. As taxes usually increase year over year, the older the base year, the more likely it is for the increase in taxes for each successive year to be higher. Furthermore, all these figures really do affect the profitability of the commercial venture, so it is imperative that these numbers are worked into all financial analyses.
When negotiating a lease, it is important to be represented by an attorney who understands the effect that these provisions can have. For more information, or for help on your next lease agreement, reach out to the knowledgeable real estate attorneys at KI Legal by calling (646) 766-8308 or emailing info@kilegal.com.
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