Understanding "Gross-Up" in Commercial Leases
The term "gross-up" typically applies to fully serviced leases, sometimes called "full-service leases." The tenant pays fixed amounts for certain services on top of a base rent for the actual space he's leasing with this type of lease.
For example, a landlord might pay for common area maintenance, also called CAM expenses, then divide this fee by the number of gross square feet in a building and charge each tenant an amount based on the percent of square feet he occupies. A gross-up clause in a lease allows that if a building is less than 90 to 100% occupied, the expenses are still calculated for the tenants' pro-rated share of operating expenses up to those percentages—90 to 100%.
Gross-up is paid as additional rent and most commonly covers variable expenses, those that can go up or down in any given month based on occupancy and other factors.
The Advantages of Gross-Up for Landlords
This is one case where you may not get what you pay for if you're the tenant. As an example, let's say that Leo Landlord has just purchased a commercial building. Tom Tenant is the first to lease space from him. Tom rents 10,000 square feet of store space. The building totals 100,000 square feet. Tom is renting 10% of the building.
In a basic pro-rata scenario that divides variable costs among tenants, Tom would pay 10% of those costs because 10% of the building is allocated to him. But now let's say that Leo has a hard time finding other tenants and this state of affairs goes on for a few months. Absent a gross-up clause in Tom's lease, Leo is stuck with footing the bill for 90% of expenses that would normally be paid for by his tenants simply because there are no other tenants he can allocate them to. A gross-up clause might allow him to bump up Tom's percent to 50%, but most likely to 95 or 100% because he's the only tenant in the building.
How Is This Fair?
Tom Tenant might not think this arrangement is fair, but Tom is, in fact, the only tenant benefiting from the services included in these variable expenses. Leo Landlord isn't directly benefiting, so it could be said that it's unfair for him to have to pay for 90% of services that only Tom uses. Perhaps one of these expenses involves maintaining surveillance cameras in the parking lot. Because there are no other tenants, the only people coming and going in that parking lot are Tom's customers, so it seems reasonable that Tom alone should pay for the service.
Read the Fine Print
If you're considering entering into a commercial lease, read the fine print carefully and protect yourself by doing a little extra homework. If indeed there is a gross-up clause in there, make sure the allowable increase is within reasonable percentages. If Tom is paying for all that surveillance equipment, he probably regrets that he didn't attempt to negotiate the percentage downward. The percentage allowed should be clearly set forth in the lease.
Moreover, if Tom had looked into Leo's past history with renting commercial buildings, he might have learned that Leo has historically had a hard time getting and keeping tenants for one reason or another. Or maybe Leo is just inexperienced—this is his first attempt at such an investment so it might take him a little time to get it right. Either way, Tom might not want to enter into a lease with Leo that includes a gross-up clause for this reason—it's more likely that he might be one of only a few tenants in the premises at any given time. If there were seven tenants leasing 70,000 square feet from Leo, the gross-up would be less, basically, the difference between 70% and 95 or 100%, and that difference would be divided among all seven tenants.