Pass-Through Expenses: Who Pays Operating Costs in a Commercial Lease

Answer

Intro: Pass-through expenses (also called operating expense recoveries) are costs a landlord passes on to tenants under a commercial lease. Instead of the landlord absorbing routine property expenses, the lease lets the landlord bill tenants for a pro-rata share of designated costs like property taxes, insurance, common area maintenance (CAM) and utilities.

Main part: Leases define which expenses are “recoverable.” Common categories include:

• Property taxes and assessments.
• Building insurance (not tenant’s business policies).
• CAM — landscaping, janitorial, security, elevators, snow removal, trash.
• Utilities for common areas (sometimes individual meters are used instead).
• Management fees, administrative charges and sometimes small repairs.

Landlords usually allocate costs by a tenant’s share of rentable square footage: Tenant Share = (Tenant RSF / Building RSF) × Recoverable Expenses. Leases may use a base-year stop (tenant pays increases above a baseline year) or full-service gross with specified pass-throughs. Recovery methods vary: some landlords bill actual monthly estimates with an annual reconciliation; others use fixed CAM caps (e.g., annual increases limited to 3–5%).

Important distinctions and negotiation points:

• Net leases (N, NN, NNN): the more “net,” the more pass-throughs the tenant pays—NNN typically includes taxes, insurance and CAM.
• Capital expenses: Many leases exclude capital improvements or amortize them over multiple years — clarify treatment and thresholds.
• Audit and documentation rights: Tenants should seek rights to inspect invoices, demand explanation, and dispute charges.
• Definitions matter: Narrowly define CAM and list exclusions (depreciation, mortgage interest, landlord’s overhead markup beyond a reasonable management fee).

Final paragraph: Pass-throughs materially affect total occupancy cost, so review lease language carefully, get clear calculation examples, negotiate caps, audit rights and capital exclusions, and ask your broker or a licensed attorney to evaluate the allocation method before signing. It’s advisable to consult a licensed professional to understand local market practices and legal implications.