Tenants Brace for Surging Office Operations Costs
By DANIEL D. WILLIAMS
Bills for California’s energy crisis and fallout from Sept. 11 are coming due for Orange County office tenants.
In March, landlords started sending out bills to tenants for operations costs tallying the difference between prepaid and actual costs for utilities, insurance, security and other items. In a normal year, the bills are marginal. But 2001 was anything but normal.
“When some tenants get that bill, there will be sticker shock,” said Tom McAndrews, chief executive of Irvine-based property manager Tiarna Real Estate Services Inc.
Tenants with so-called triple-net leases,those that pass along operational costs such as electricity, taxes, insurance and security,are set to bear the biggest brunt, real estate sources said. Landlords saw big jumps in electricity costs early last year, while security and insurance expenses jumped after Sept. 11.
“No one has their head stuck in the sand,” said Dave Rock, senior vice president of management services for the Irvine office of Chicago-based Transwestern Commercial Services. “Emotions ran high after Sept. 11, so tenants were agreeable to pay more for security. But how long will that last?” Tenants are in for a double-whammy. Along with a bill for added 2001 expenses, most are seeing their monthly payments for 2002 operating expenses skyrocket.
In one Irvine high-rise owned by Chicago-based Equity Office Properties Trust, monthly operating expenses for a 10,000-square-foot tenant went from $85 a year ago to $1,200 this year.
Landlords base cost hikes on a tenant’s base year, or when a lease was signed. In the case of the Irvine tenant, 2002 operating expenses are estimated at $2.8 million, or 30% higher than the tenant’s 1999 base year.
The key is knowing the big bills are coming. One Equity tenant, Charley Hurst, a partner with the Irvine office of Snell & Wilmer LLP, said he prepared himself for the worst.
“We’re a 40,000-square-foot tenant and I was pleasantly surprised at the increase,” Hurst said.
The Phoenix-based law firm has offices in the 12-story 1920 Main St. Building near John Wayne Airport. As a high-rise near an airport, the building is seen as a higher insurance risk in the wake of Sept. 11, he said.
Hurst didn’t offer details but said he believes renting from Equity, the nation’s largest property manager, affords him a better deal on insurance rates.
“They may be able to sign national deals with insurers to keep insurance costs down,” he said. “That’s something smaller landlords might not be able to do.”
But not everyone just pays the added costs. In New York, Chicago and other markets, lease audit firms are doing brisk business on behalf of tenants that want to be sure they aren’t being gouged by landlords.
Some tenants argue that landlords hide costs and overcharge tenants by dumping tenant improvement costs into their laps.
The devil is in the lease details, local real estate sources say.
Some tenants might overlook or not grasp all the potential hidden costs at the time they sign a lease, according to Tiarna’s McAndrews
“There’s language in there they might not notice,” he said.
In general, landlords pay capital costs, leasing and tenant improvements, according to George Economos, a broker with the Irvine office of NAI Capital Commercial Real Estate Services who represents both tenants and landlords. But any questions about who pays for what should be ironed out before signing a lease, Economos said.
If a building needs upgrades, a tenant’s broker should negotiate to have those done before the tenant moves in, “so the tenant won’t have to pay for it,” Economos said.
Some brokers are pushing for a Proposition 13-style cap that would limit tax increases to 2% per year for tenants, Economos said.
But there’s a reason for passing on costs, according to McAndrews.
“It’s so the lease amount the landlord agrees to isn’t eaten away by all the additional expenses,” he said.
Take a 70,000-square-foot building in Irvine, he said. In 2000, insurance costs were $11,000 annually. That climbed 70% to $19,000 in 2001, he said, and grew another 30% to $25,000 this year.
After Sept. 11, security expenses also jumped. At Equity’s 2600 Michelson building in Irvine, security guards now do hourly sweeps of parking lots checking licenses plates against those on record for tenants.
While spikes in utility costs hit first, they now are getting under control, according to McAndrews.
In the same 70,000-square-foot Irvine building McAndrews cited for insurance, electricity costs hit $122,000 in 2000, jumped to $172,000 in 2001 and are pegged at $175,000 for 2002.
“I think utilities will be fairly stable for the foreseeable future,” McAndrews said.
Some landlords have turned to metering as a way to more fairly pass on electricity costs, according to Transwestern’s Rock.
“This way, tenants will pay a direct cost per their usage, rather than having it spread among the tenants,” he said.
Retrofitting of lighting and other energy-saving measures also have helped, he said.
Like energy costs, McAndrews said he believes insurance and security costs will gradually back off. That could make 2001 the high-water mark, he said.
“If you sign a lease in 2002 or 2003, you might never exceed that level,” McAndrews said.
