Negotiating Tactics: Replacement Obligations and American with Disabilities Act

The Logistics of Leasing

Replacement Obligations

The responsibility of replacing building systems as needed also varies by the lease contract. Some tenants maintain that it is the landlord’s building; therefore, the landlord should be responsible for replacing all building systems like they would in an apartment. Some landlords maintain that the tenant is using each building system while they occupy the property; therefore, the tenant should be responsible for replacing the building systems because they are in control of them.

The most common example of the replacement clause is the replacement of the HVAC units on the roof of the building. What if one of the units die after you’ve been in the building for two years? Do you call your landlord, notify them and they replace it? Do you have to replace it at your own cost and with your vendor? The answer is different in each lease and warrants carefully considered. One HVAC unit is $5,000-$10,000, depending on the unit’s locale, type, and tonnage. One HVAC unit going down on a 100,000 SF building is annoying, but it is not a significant expense. What if you are like one of my clients that runs a diagnostic laboratory in 100,000 SF, and they have 20 HVAC units? Now you can see why you would want to be crystal clear about this provision. If each HVAC unit lasts 15 years, you would be replacing one or two HVAC units each year. Maybe three or four at one time if they were of the same vintage.

Another logistics to negotiate is when a replacement is required. The standard language for HVAC replacement in the AIR lease calls for replacement when the cost of repair is greater than 50% of the cost of replacement. I have found this logic to be acceptable to both sides.

Now how does this replacement work in practice? The standard AIR lease language stipulates that it is the landlord that contracts and pays for the HVAC replacement. The landlord is then able to bill back for a portion of the cost of the replacement. The expense that the tenant is responsible for is proportionate to the length of the lease divided by the HVAC’s useful life. Twelve years is the generally accepted useful life amortization schedule.

As with everything else in this leasing process, there is nuance here too. Some lease language states that the numerator is the total length of the lease term. Some leases say that the numerator is the total amount of time left on the lease at the time of replacement. Let’s use an extreme example to make it easy to understand the ramifications of the two approaches.

Let’s say you have a 6-year lease. Halfway through it, you have two HVAC units that need replacing for a total of $10,000. If you have the term of the lease as the numerator, you are responsible for reimbursing your landlord for 6/12’s, or 50% of the replacement, totaling $5,000. If you have the remaining lease term language in your lease, then you would be responsible for 3/12’s worth of the replacement units which would be 25%, or $2,500. In a 200,000 SF building with 20 HVAC units, this makes a small difference of $50,000 if you had to replace every unit there. In a 5,000 SF building for a small business, this is one- or two-months’ worth of extra rent equivalent that is due immediately. That is the same as paying double rent every time this happens.

When negotiating the lease, you must frame the issue in the context of proportionality. You might be okay with being responsible for paying for a portion of the new HVAC units’ useful life but not paying for a part of the new unit while you still had the old unit.

The accounting standards provide for a 12-year useful life for accounting purposes. Still, anybody that has operated an industrial building can tell you, HVAC units can last 12, 15, 20, and 25 years if properly maintained.

Why should you be responsible for paying for the old unit once it is past its useful life? If you did that, the landlord might have already had a prior tenant pay for the HVAC unit, and you are paying them again for that same unit. The replacement of building systems is structured to be an equitable sharing of expenses, not a profit center. A careful review and discussion on this are usually necessary.

American with Disabilities Act

The American with Disabilities Association act requires upgrading buildings accessibility periodically to ensure that buildings comply with the current ADA code. In general, the ADA code requires that the building provides a clear and accessible path of travel available for someone with disabilities to be able to access the property. Accessibility is not limited to the entrance to the building. Instead, it encompasses the parking lot, sidewalk, and the path of travel through all doors, to the downstairs and upstairs office, into the restroom stalls and sink areas, and throughout the building.

Everybody agrees that the ADA is essential. The difficulty with ADA improvements usually centers around who is responsible for making the upgrades and when. The knee jerk reaction for every tenant is that the landlord should be responsible for this because it is their building. The landlord’s view is that a building must be compliant when it is built. Every tenant that inhabit the building after that has its own use and each use has different ADA requirements. If the tenant’s use requires upgrades, then the tenant should be responsible for making those upgrades.

A good way to estimate who will bear the cost of an ADA upgrade is by understanding if the building requires construction regardless of who is going to occupy it next. Construction requires permits, and permits require ADA inspection, so this is the trigger point for this discussion in negotiations. If the building would require construction no matter who is going to occupy it next, then it is practical that the landlord is going to make these improvements. If on the other hand, the building wouldn’t require any ADA upgrades for a new tenant, but your use has a special component to it, like it is open to the general public, then you will likely be responsible for these improvements.