How Apartment Owners Should Structure Operations Costs in Retail Leases

Retail is becoming a standard on the bottom floor of apartment communities, and while the storefront looks like any other, there are key differences in how the operations expenses, like property taxes and insurance are charged for retailers in apartment communities versus shopping centers.

“Operating expenses in a multi-family project that are passed-through to the retailer should be dealt with differently than in a conventional shopping center because many of these expenses do not benefit the retail tenants,” Gary Glick, a partner with Cox, Castle & Nicholson, tells Glick says that there are two standard ways to properly cover operating expenses. One it is the pro rata share of all of the operating expenses for the multifamily project and the other is by reasonably allocating operating expenses attributed to the retail tenants.

In the pro-rata example, the retailer’s share of the expenses would be in proportion to the retailer’s leaseable space within the property. “This is probably not the best way to determine the retailer’s pro rata share of operating expense because the retailer is paying a share of expenses relating to common areas for the residential tenants, but without the right to use that common area, including the parking for the residential units,” says Glick.

On the other hand, depending on the layout of the property and the retailer’s leasable area, the estimate could be miscalculated in the retailer’s favor. “The denominator used to determine the pro rata share includes the floor area of all of the residential units, along with the floor area of all of the retail premises,” says Glick. “Depending on the density of the project and the number of residential units, this calculation may not accurately account for the retailer’s share of operating expenses.”

The alternative is to factor the retailer’s share of operating expenses in proportion to the leaseable space to other leaseable retail space. “An alternative method of determining the retailer’s share of operating expenses is to have the landlord reasonably allocate those operating expenses that should be allocable to the retail tenants,” says Glick. “The retail tenant would then pay its pro rata share of these expenses based upon a percentage determined by comparing the floor area within the retailer’s premises to the floor area of all of the leasable retail space within the multi-family project.”

For Glick, this is the preferred method. “This is a more accurate way to determine the retailer’s share of operating expenses, but it requires the retailer to trust that the developer will accurately allocate the operating expenses that relate to the retail project,” he says. “Certainly, the parties can attempt to define these expenses.  For example, it is commonly accepted that operating expenses relating to exclusive common area amenities for the residential tenants, like pool area, concierge service, exclusive parking, should not be chargeable to the retail tenants.”