An issue that can lead to disputes in commercial leasing is whether a landlord can pass capital expenditures through to tenants as part of their CAM charges or operating expenses. The short answer is: it depends entirely on your lease language. Capital expenses are another item to check against your lease.
For the wider list of what a lease can pass through, see what landlords can include in CAM charges.
What Counts as a Capital Expenditure?
A capital expenditure (CapEx) is a cost that adds value to the property, extends its useful life, or creates a new asset. This is distinguished from an operating expense (OpEx), which covers the routine cost of maintaining and operating the property.
Here are some practical examples to illustrate the difference:
- Operating expense: Patching potholes in the parking lot, repairing a section of roof, servicing an HVAC unit, replacing a broken window.
- Capital expenditure: Repaving the entire parking lot, installing a new roof, replacing the HVAC system, renovating the building lobby.
The key distinction is between maintaining an existing asset (operating) and replacing or substantially improving it (capital). While this distinction seems clear in theory, the line is often blurry in practice, which is why disputes arise frequently.
What Most Leases Say About Capital Expenses
Commercial lease agreements typically handle capital expenditures in one of four ways:
1. Full Exclusion
The lease explicitly states that capital expenditures are excluded from operating expenses and cannot be passed through to tenants. This is the most tenant-friendly position and is common in well-negotiated leases.
2. Amortization Over Useful Life
The lease allows capital expenditures to be passed through, but only if they are amortized over their useful life. For example, a $150,000 roof replacement with a 20-year useful life would be amortized at $7,500 per year (often with interest). The tenant only pays their proportionate share of the annual amortized amount, not the full cost in a single year.
When reviewing amortized capital expenses, verify:
- The useful life period is reasonable for the type of improvement
- The interest rate (if applicable) is specified in the lease or is reasonable
- The amortization stops when the useful life period ends
- Your lease actually authorizes amortized pass-throughs (don't assume)
3. Limited Pass-Through
Some leases allow only certain categories of capital expenditures to be passed through, typically those that are required by law (such as ADA compliance upgrades) or those that reduce operating costs (such as energy-efficient equipment that lowers utility bills). Even in these cases, the expense is usually required to be amortized.
4. Broad Pass-Through
Less common in modern leases but still encountered, some leases use broad language that effectively allows all building costs, including capital improvements, to be passed through. Tenants negotiating new leases should be cautious of vague definitions like "all costs associated with the ownership, operation, and maintenance of the property."
Common Capital Expense Problems
Even when the lease language is clear, capital expenses create problems for tenants in practice:
Misclassification of Capital Work as Repairs
A major project may be classified as a "repair" and passed through in full as an operating expense, rather than amortized if your lease requires amortization. For example:
- A complete parking lot resurface billed as "parking lot repairs"
- A full HVAC system replacement billed as "HVAC maintenance"
- A roof replacement billed as "roof repair"
- A lobby renovation billed as "building maintenance"
If you see a large one-time charge in a maintenance or repair category, request the underlying invoices. The scope of work will often reveal whether the project was truly a repair or a capital improvement.
Incorrect Amortization Calculations
When capital expenses are properly amortized, errors can still occur in the calculation:
- Useful life period is too short, increasing annual charges
- Interest rate is higher than what the lease permits
- Amortization continues beyond the useful life period
- The full cost is used as the basis rather than the net cost (after warranties, insurance, or rebates)
Capital Expenses Inflating Management Fees
If capital expenses are improperly included in operating expenses, and the management fee is calculated as a percentage of total operating expenses, the management fee is also inflated. This creates a compounding overcharge.
How to Protect Yourself
- Review your lease language. Find the section defining operating expenses and look specifically for how capital expenditures are addressed, are they excluded, amortized, or broadly included?
- Compare year-over-year expenses. Sudden spikes in repair or maintenance categories may indicate capital work being classified as operating expenses.
- Request invoices for large charges. Any single charge that represents a significant portion of a category total deserves scrutiny.
- Verify amortization schedules. If your landlord is amortizing capital expenses, request the amortization schedule showing the total cost, useful life, interest rate, and annual charge.
- Check your CAM cap. If your lease has a CAM cap, confirm whether capital expenses are inside or outside the cap, and whether the cap is being applied correctly.
For a complete framework for reviewing your charges, see our commercial lease audit checklist.
How LeaseGuard Helps
When you upload your lease and CAM reconciliation statement, LeaseGuard flags statement lines whose labels look like capital items (for example, a roof replacement) or fall under a category your lease excludes, so you can ask the landlord about them. These are possible issues for your review, not conclusions. LeaseGuard does not read invoices, decide whether work was a repair or a capital improvement, or check amortization schedules, useful lives or interest. Whether a cost can be passed through depends on your lease and applicable law.
Key Takeaways
- Whether capital expenses can be passed to tenants depends on your specific lease language
- Leases differ: some exclude capital expenses, some require amortization over useful life, and some use broad language that may include them
- Capital work classified as a repair can be passed through in a single year, which may be an overcharge if your lease does not allow it
- Always request invoices for large one-time charges in repair or maintenance categories
- Capital expenses improperly included in operating costs also inflate percentage-based management fees