Operating expenses vs property outgoings
Outgoings is a general term used to describe the recovery of cost from the tenant for expenses associated with the holding, running and maintenance of a commercial property during the term of a lease.
Operating expenses are items such as telephones, internet, electricity and business insurance that help to operate your business. Base property outgoings generally include council rates, water rates, building insurance and land tax, cleaning, gardening/maintenance, grounds maintenance, general property maintenance, common electricity, security and lift servicing.
Other property outgoings may include fire safety inspections/certifications/repairs, air conditioning servicing/repairs/replacement and property management fees.
We touched on property outgoings in one of our previous blogs – Commercial Property Yields: What you need to know before investing | Chapman & Frazer Commercial Real Estate.
Net vs Gross Rent
As a tenant, you need to identify whether the advertised rent for a commercial property is net or gross. If it is a net rent you will be paying the property outgoings. If it is a gross asking rent, the property outgoings have already been factored into the asking rent. Even under a gross rent structure, you may still be liable for some property-related expenses such as servicing and maintenance of an air conditioning system.
Be mindful of the outgoings you will be required to pay under a net rent structure, and keep in mind for budgeting reasons that outgoings can fluctuate beyond normal inflation rates from year to year.
Tip: As outgoings will fluctuate from one year to the next, you should always leave a contingency in your budget for an escalation.
How are outgoings calculated?
How outgoings are calculated will largely depend on the type of property you are leasing. This will be determined by whether it is a freehold building, part of a larger non-strata title building, or is a strata title property.
For both freehold properties and strata title properties, in most instances the outgoings will be calculated at 100% due to the tenant occupying the entire property. For tenants occupying part of a larger building (non-strata title), the outgoings will generally be calculated as a percentage, with the amount of space occupied representing the percentage of the total space in the building.
Example: Picture an industrial complex with twelve (12) units and each unit is individually owned as it is a strata title complex. In this scenario, any outgoings for the leased property will be applicable to the individual unit only and therefore can be charged and calculated at 100%.
If we consider the same industrial complex, but rather than being a strata title property the whole complex is owned by one person in this scenario. The tenant should now be charged outgoings based on 8.33% or 1/12th of the entire property (assuming each unit is the same size), as outgoings will be levied against the aggregate complex, not the individual units.
Are any outgoings excluded?
The answer is, yes. Certain outgoings are commonly excluded in net leases. The most common items that are excluded or limited are as follows:
- Strata levies (part) – strata levies are usually comprised of two parts, being the administrative fund (day-to-day running costs) and “the capital works fund” (think longer-term upgrades).
It is common for a tenant to pay the “administrative fund component” but far less common for them to pay “the capital works fund” component.
- Land tax – Most leases will state that land tax must be calculated on a single holding basis, meaning it is the only property owned by the owner and is not owned by a non-concessional trust/entity. What this means; The tenant should get the benefit of any tax-free threshold offered by the government, which will mean they are charged the minimum rate payable.
- Capital works – The vast majority of net leases will state that an owner cannot recover any outgoings of a capital nature. As an example, if the owner wanted to add an additional lift in a commercial building they would not be able to claim this as a “maintenance cost” as it is really a capital upgrade to the building.
How are outgoings charged?
Outgoings are generally either charged to tenants on a budgeted monthly basis, or an ad-hoc basis where the outgoings are recovered as they fall due (or as they are levied against the owner).
If outgoings are being charged on a budgeted monthly basis, the owner or their agent should provide a budget showing the estimated annual outgoings for the year.
These outgoings should reflect the outgoings charges that are agreed as recoverable (payable by the tenant) under the lease, including what percentage of the outgoings are recoverable. The annual outgoings estimate is then used to calculate the monthly installments that are payable by the tenant. An annual reconciliation should also be done by the owner or their agent, to determine any variation between the budgeted and the actual outgoings.
If the actual outs exceed the budget, the tenant will be issued an invoice for the shortfall. If the actual outs are lower than the budgeted outgoings, the tenant should be issued a refund.
If outgoings are charged on an ad-hoc basis, the owner or their agent will invoice the tenant to reimburse a charge (e.g council rates) once the invoice/charge is levied on the owner. This avoids the need for budgets and reconciliations, but is not as simple as the tenant simply budgeting a regular monthly payment.
If you have any queries, please contact us anytime.