I have written before about the definition of a NNN lease. It is a lease where, in addition to the tenant paying a base rent, they also reimburse the landlord for expenses, including taxes, insurance and common area operating expenses. Each year the landlord will prepare a budget for those NNN expenses, typically based on the previous year’s actual expenses plus any forecasted increases.
If your business has a triple net (NNN) lease, you will receive a reconciliation letter from the landlord, usually by the end of the first quarter after the calendar year ends. The purpose of this letter is to reconcile the estimated monthly payments made during the prior year with the actual expenses incurred for common area maintenance (CAM), building insurance, and real estate taxes.
At the end of the year, the landlord will compare actual expenses to those that the NNN budget contained. If the actual expenses exceeded the budget, then the landlord will send out a bill for those differences to the tenant. That is the reconciliation process.
It is critical that a tenant review any reconciliation very carefully to make sure these additional expenses are actually applicable to their tenancy. A tenant has the right to request a copy of the reporting that was done so they can review and check for accounting errors or mistakes in billing.
An especially tricky expense is capital expenditures. Capital expenditures are items like repairing/replacing the roof or an HVAC system. Other operating expenses, such as janitorial, landscaping, and parking-lot maintenance are controllable expenses.
Capital expenditures are funded over a period of time (the “useful life” of the improvement), controllable expenses are annual expenses, and uncontrollable expenses (property taxes, insurance and utilities) are expenses you pay to the landlord as billed.
Capital expenditures are normally billed separately since they are not a normal part of the common area expenses, but some leases allow them to be amortized into the operating expenses, and a tenant will want to make sure they are not double-billed or billed for something that is specific to another tenant.
A tenant should always reach out to their commercial real estate agent to assist with the review of these expenses. The role of an agent does not stop once the lease is signed. They are there throughout the process to make sure a tenant can focus on what is most important, their business.
Brian Johnson is the new president of the Santa Barbara Association of Realtors. He is a California licensed real estate agent and the managing director of Radius Commercial Real Estate. Brian handles all types of commercial real estate transactions, but has a special focus on multifamily investments. He can be reached at 805.879.9631 or firstname.lastname@example.org.