GBREB / Commercial Brokers Association, Continuing Education Unit –Commercial Leasing

1. III. DEMYSTIFYING THE GROSS-UP PROVISION
(OR WHY THIS ACTUALLY MAKES SENSE
FROM the perspective of BOTH LANDLORD
AND TENANT)
Assumptions
1. Building is 100 square feet.
2. Tenant XYZ occupies 50 square feet, and its percentage share is 50%.
3. Annual cleaning costs are $1.00 per square foot.
4. Empty offices are not cleaned.
5. Gross-up provision in lease reads: “With respect to those elements of Operating Costs
which vary based upon occupancy, if the Building is less than 95% occupied, the
amount of such variable costs to be included in Operating Costs shall be “grossed up”
to the amount that such costs would have been had the Building been 95% occupied.”
(Note that a gross-up provision should only apply to costs, such as cleaning, that vary
based upon occupancy.)
Analysis
1. Since cleaning costs $1.00 per square foot and XYZ occupies 50 square feet, it utilizes
$50.00 worth of cleaning services (50 square feet x $1.00).
2. If the Building is 100% occupied, cleaning costs are $100.00 (100 square feet x $1.00).
Since XYZ’s percentage share is 50%, XYZ pays for $50.00 of cleaning. This matches
the amount of cleaning that XYZ actually uses.
3. However, if the Building is 75% occupied, then total cleaning costs are $75.00 (since
empty offices are not cleaned). Absent an adjustment, XYZ will pay for $37.50 in
cleaning services ($75.00 x 50%), but will still utilize $50.00 in cleaning services. This
is a windfall to XYZ of $12.50.
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2. III. DEMYSTIFYING THE GROSS-UP PROVISION
(OR WHY THIS ACTUALLY MAKES SENSE
FROM the perspective of BOTH LANDLORD
AND TENANT)
4. Without an adjustment, Landlord collects $37.50 from XYZ and $18.75 from the
occupant(s) of the remaining 25% of the Building that is occupied ($75.00 x 25%), for a
total of $56.25. But since Landlord has to pay the actual cleaning costs of $75.00, this
represents a shortfall of $18.75 ($75.00 - $56.25). This is a penalty to Landlord (since
Landlord must pay it, but none of it is properly attributable to the 25% of the Building
that is vacant and not being cleaned).
5. The effect of the gross-up provision above is to gross up cleaning costs to what they
would have been had the Building been 95% occupied, or $95.00 (95% occupancy = 95
square feet, x $1.00 per square foot). XYZ pays 50% of this, or $47.50. Since XYZ is
still using $50.00 worth of cleaning services, it is actually still getting a windfall of $2.50
(which is 5% of $50),and Landlord is still incurring a penalty, but in both cases the
amount is reduced to 5% (the imputed vacancy factor) rather than reflecting the actual
vacancy factor (25% in our example).
6. Thus, rather than harming tenants, the gross-up provision in fact usually leaves them
ahead of the game -- with a 95% gross-up provision, tenants still get a windfall of 5% of
the cost of the variable cost items which they utilize. The windfall/penalty will only be
completely eliminated by a gross-up to 100%, which is a less common provision -- but
even at 100%, the gross-up provision is merely neutral to tenants and not a penalty.
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3. IV. YOUR FRIENDLY NEIGHBORHOOD
LAWYER’S LOI WISH LIST
Key Practice Points: In addition to the things mentioned above, there are several things that
you can do in the LOI to make the lease drafting process smoother and more efficient (and
therefore faster).
1. Specific things lawyers always want to know:
a. All of the items listed above
b. Is the space currently vacant?
c. Does any other tenant have prior rights in the space?
d. What is the exact name of the Tenant entity? Remember, unless you have seen
financials for the exact Tenant entity named in the lease (not something that is
similar, such as IBM Corp. vs. IBM Co., and not a parent or affiliate of the Tenant
entity), then you have no assurances that the Tenant entity has any assets
whatsoever. Knowing that its parent is rich isn’t good enough; a subsidiary
corporation is like a child who over 18 -- the parent is not legally obligated to pay
its debts.
e. If there is free rent, specify whether the term (e.g., five years) runs from the
Commencement Date or the Rent Commencement Date. Ditto for when the rent
bumps occur -- the anniversary of the Commencement Date or the Rent
Commencement Date? Does free rent include base rent only, or also OpEx, Taxes
and/or electricity?
f. If there is a security deposit of X months’ rent, specify whether it is based on the
initial rent, the ending rent or the average rent.
g. State how electricity will be handled. Is it included in Operating Expenses?
Does Tenant pay a separate electricity charge to Landlord, and if so, is it subject
to increase? Is the space to be separately metered (Tenant pays directly to the
utility company) or sub-metered (Tenant pays to Landlord based on actual usage),
and if so, is the meter already in place? If the meter is not already in place, who
will pay for it? Note that how electricity is handled can go by different
terminology, so please spell out what you mean. In other words, instead of saying
the lease is “full service” say “electricity is included in OpEx.”
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4. IV. YOUR FRIENDLY NEIGHBORHOOD
LAWYER’S LOI WISH LIST (cont’d)
h. If this is an extension and there is a TI allowance, state whether it can be
used immediately or only after the new term begins.
i. If this is an expansion and there is a TI allowance, state whether it can be
used anywhere in the premises, or only in the expansion space.
j. Lawyers understand the desire to see a date certain for a commencement
date in the LOI. However, if the Tenant is doing the work, they are not going
to accept this – they want XX days after Landlord delivers the space to do their
buildout, not a commencement date of February 1. While you may get away
with February 1 in the LOI, it won’t stay in the lease. Tell your lawyer how
many days Tenant's build-out period will be.
k. If Tenant has antenna rights, what is the maximum size of the antenna, and
how much rent will there be?
2. Feel free to call your lawyer BEFORE the LOI is signed if there is language or
concepts you are not sure of or want to run past them. This can make a huge difference
later. Most leasing lawyers understand that the LOI needs a big-picture focus and will
not raise unnecessary issues at this stage. (Contrary to the widespread urban legend,
lawyers almost never actually charge by the word.)
3. If there are fees or other economic terms, disclose them up front and put them in
the LOI. This particularly includes construction management fees and parking fees,
both of which Tenants have balked at paying if they are not specified in the LOI.
Similarly, if there is an extension option, the LOI must state if there is to be a floor of
“not less than current” on the extension term rent. Otherwise, Landlord probably won’t
be able to get this point. In general, ambiguity or silence in the LOI on key issues does
not benefit anyone, and can in fact greatly delay lease signing.
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© Goulston & Storrs 2010. All rights reserved.

5. IV. YOUR FRIENDLY NEIGHBORHOOD
LAWYER’S LOI WISH LIST (cont’d)
4. Always leave room for change in the future. Rather than say that the Building has a
fitness center, say that it “currently” or “presently” has one -- otherwise, Tenants can
insist (and have done so) that Landlord be obligated to keep the fitness center
throughout the lease term. Similarly, be sure to say that the current monthly parking
charge is $XXX, and/or that $XXX is subject to change. Be especially wary of
specific language about security procedures in the LOI since these change often. If
you do include this language, be sure to state that this is what Landlord is “currently”
or “presently” doing.
5. Understand that certain things cannot be drafted in the alternative. If the amount
of the security deposit has not been decided, the lawyer can insert TBD and send out
the lease. If you don’t know if the electricity will be separately sub-metered or
included in Operating Expenses, the best the lawyer can do is include one option in
the lease with a note that it may be changed in a later draft. If you don’t know if
Landlord or Tenant is doing the work, as noted above the lawyer can’t do any drafting
until the decision is made.
6. Don’t be afraid to make suggestions to the lawyers you deal with about how they
might handle things better, either at the LOI stage or at the lease stage. You have a
perspective on lease deals that they don’t, so help them to help you.
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