Pass Through Costs of Enhanced Telecom Services

To attract and keep sophisticated tenants in today's softening real estate market, you may be forced to enhance your building's telecommunications systems—with either upgrades or a brand new system. For example, some owners are installing a “centralized distribution system” (CDS) for telecom services in their buildings (see the box on p. 6 for an explanation of a CDS), additional telecom risers, or additional “points of entry.” (Points of entry are conduits through the building's foundation that connect to conduits in the street.)

Although these telecom enhancements may allow you to satisfy tenant demands for complex telecom services in their space, like high-speed Internet access, they can be extremely expensive. And if your leases are like many we've seen, they may contain this costly loophole: Nothing in the leases authorizes you to pass through to your tenants the costs of installing and maintaining these enhancements. So, for example, if you charge your tenants or their telecom providers a fee for using the CDS or for the cost of maintaining your building's CDS, they may argue, and a court could agree, that your installation and maintenance costs for the enhancements shouldn't be covered in your operating expense definition. You may then be stuck footing the bill for them, warns New York City real estate and telecommunications attorney Jeffrey A. Moerdler.

To plug this loophole and give yourself maximum flexibility in the future, revise your lease's operating expense definition so that all these costs are covered, says Moerdler. We've provided you with Model Lease Language that you can use in your leases.

Revise Operating Expense Definition

Modify your lease's operating expense definition in the following two ways, says Moerdler:

Cover general telecom-related costs. Even if your operating expense definition includes general building-related expenses, that may not be good enough to protect you, warns Moerdler. A tenant could still argue that it doesn't cover telecom costs, he says. To avoid disputes with the tenant, give a laundry list of the expenses that must be covered as general telecom-related costs, he says.

Make sure the list includes the costs of upgrading, operating, maintaining, and repairing your building's telecom system, says Moerdler. (But don't include such major telecom expenses as telecom system installation and replacement costs in your list, since they must be addressed differently, he notes.) Moerdler suggests adding the following language to your operating expense definition:

Model Lease Language

(x) All costs incurred in installing, upgrading, operating, maintaining, and repairing the Building's communications infrastructure, including, without limitation, points of entry, centralized distribution systems, wires, cables, conduits, antennas, and related items.

List major telecom work as included capital expense. If you do any major work to your building—such as constructing, installing, or replacing a telecom system—tenants will argue that those large costs must be considered a capital expense, not an operating expense, warns Moerdler. Many leases say you can't pass through capital expenses, except in limited circumstances—such as capital expenses required by law or those that are cost-saving in nature.

To protect your wallet, add a new capital expense exception—that is, a capital expense that you can pass through to the tenant—to the operating expense definition, says Moerdler. The new capital expense exception should cover the costs of designing, constructing, installing, and replacing the parts of your building's telecom system, he says.

To do this, add the following language to the list of capital expense exceptions:

Model Lease Language

(x) All costs for improvements which, although capital in nature, Landlord determines, in its sole discretion, are necessary to enhance the Building's communications infrastructure, including, without limitation, costs incurred in designing, constructing, installing, and replacing points of entry, centralized distribution systems, cables, conduits, antennas, and related items.

Points to Negotiate with Savvy Tenants

Savvy tenants may raise some points that you'll need to negotiate, says Moerdler. The result of the negotiations will depend on the strength of the tenants, he says.

Amortization of capital expenses. A tenant may refuse to fully pay for these capital expenses in the year that you incurred them, says Moerdler. Instead, it may demand that you amortize those expenses over their useful life, he says.

Your reasonableness. A tenant may demand that you agree to pass through only the capital expenses that you reasonably determine are necessary, says Moerdler.

No further charges. If you pay for the installation of a CDS at your building, you'll most likely charge an access fee if a tenant or its telecom provider wants to use the CDS, says Moerdler. Tenants typically don't have a problem with paying an access fee in that situation (although telecom providers typically object to such a fee), he says. But if a tenant pays for the installation of the CDS, it will most likely refuse to pay an access fee too.

Spending limit. A tenant may demand that you put an annual cap on how much you can spend on your building's telecom system, says Moerdler. If you agree to a cap, make sure that the amount is high enough to allow you to keep your building's telecom system operating smoothly and efficiently, he advises.

CLLI Source

Jeffrey A. Moerdler, Esq.: Partner, Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, PC, 666 Third Ave., New York, NY 10017; (212) 935-3000; jamoerdler@mintz.com.

Sidebar

* What's a Centralized Distribution System?

A “centralized distribution system” (CDS) is a master telecommunications infrastructure that makes a variety of telecom services possible in a building, says New York City real estate and telecommunications attorney Jeffrey A. Moerdler. It's versatile because it typically contains many types of wires—such as single mode and multimode fiber optics, high-speed copper wires, and coaxial cable, he explains. An owner or a third party designated by an owner typically installs the CDS and then remains in charge of its operation and maintenance, he adds.

All tenants and telecom providers in the building can and often are required to use the CDS, says Moerdler. They connect in a telecom closet located on an individual floor in the building's main telecom room or in a “meet me room,” he says. (A meet me room is where all telecom providers' wires enter a building.) Since the CDS provides a single, unified telecom system, it reduces the need for wiring in the building's telecom risers, Moerdler says.