Negotiating Operating Expense Escalations in Retail Leases

Operating expense escalations are the single most consequential financial provision in a retail or office lease after base rent and percentage rent. They determine what the tenant actually pays over the life of the lease, and in our experience, landlord first drafts routinely contain between six and ten provisions that a competent tenant-side negotiator will move. This memo is a working checklist for in-house counsel and general managers approaching renewals in 2026.

The base-year reset is where the leverage is. In a standard base-year lease, operating expenses are passed through only to the extent they exceed the base-year total, which resets each lease term. Landlords will routinely propose that the base year be adjusted for full occupancy ("gross-up") but will, less routinely, offer that the gross-up also apply to the comparison years — the mirror-image adjustment that protects the tenant when occupancy changes during the term. If the landlord is grossing up the base, insist on a parallel adjustment in the comparison year calculation. Omitting it is one of the most common hidden value transfers in a retail lease.

Management fees routinely appear as a separate line in operating expenses and are a priority item to cap. Uncapped percentage-of-gross-receipts management fees in a center with strong sales can grow substantially faster than the underlying services justify. We generally negotiate a cap expressed as a percentage of operating expenses (typically 3% to 5%) and a fixed ceiling on the dollar amount per square foot. Where the landlord is a large REIT with an affiliated management company, we also negotiate a most-favored-nation clause relative to the fees charged to the REIT's other tenants in the same market.

Capital expenditures are the second-largest source of dispute. A well-drafted tenant exclusion will exclude capital items except those required by (a) a change in law first effective after the lease is signed, or (b) a repair that will demonstrably reduce operating expenses, in which case the inclusion is amortized over the useful life of the improvement and capped at the annual savings generated. Landlord first drafts typically include all capital expenditures without amortization; the tenant-side move is to push both the exclusion and the amortization.

Audit rights, caps on annual escalation (typically 5% year-over-year on controllable expenses), exclusions for landlord's general corporate overhead, exclusions for expenses recovered from insurance, and exclusions for expenses specifically paid by another tenant — all of these are standard tenant-side provisions that should be requested as a matter of course. Whether the landlord agrees depends on market leverage, but tenants who do not raise them routinely pay several dollars per square foot per year in recoveries that are, in many markets, genuinely negotiable.

For multi-location retailers renewing multiple leases concurrently, it is often worth centralizing the operating-expense review under a single lease-administration process with a standard form of tenant-favorable provisions. The per-lease negotiating effort is substantially higher than most operators budget, and consistent provisions make downstream audit and dispute resolution meaningfully cheaper.