Figuring out the small print can be confusing when you’re looking at a commercial real estate lease.
One of the terms that often confuses people is the expense stop. But misinterpreting how expense stops work can cost you tens of thousands a year.
We’re going to take a look at what expense stops are and the base year expense stop (which is a type of expense stop). As a result, you can decide which one works best for you.
An expense stop is the maximum amount of money per year that a landlord has to pay for expenses. For example, let’s say that there are three tenants, and that the expense stop for each tenant is $50,000 dollars a year. If the total operating expenses for the year add up to less than $150,000, then the landlord will be required to pay the total amount.
If, however, the total operating expenses add up to $200,000, then the difference between the expense stop and the actual operating costs, which is $50,000, will be split up by all three tenants.
Base Year Expense Stop
A base year expense stop is a type of expense stop. The value of Base year expense stop is set and based on a calendar year, whereas that of an Expense stop is an established dollar amount.
In this case, the maximum operating expenses for the year are determined by the first year of the tenant’s lease. In other words, if for that year the operating expenses are used as a basis for determining future operating expenses.
So let’s say that during the base year, the landlord’s operating expenses for a property are $175,000. Then in subsequent years, if operating expenses rise above that amount, the tenants will be required to pay the difference, split between them.
A base year expense stop is useful for it does not expand landlord’s operating expenses during the lease term. Therefore, landlords may choose to include base year stop expense into full-service leases to secure their operating income.
During the lease term, expenses may get bigger and the landlord may charge the tenant for those expenses, instead of accepting them on his behalf.
Pros And Cons Of Base Year Expense
On the plus side, base year expense stops aren’t based on an arbitrary number. Therefore they give a more realistic estimate of what operating costs should be. Because it’s based on the actual history of expenses of the property, it can also be easily verified.
On the other hand, some tenants might worry that the operating expenses are being manipulated by the landlord, and may request an audit. At the same time, an arbitrary expense stop can be risky for a new property, since there is no history on which to base a reasonable estimate. The drawback of Base Year Stop is that the landlord is able to operate during the period of establishment.
The best thing to do in that case would be to use a base year expense stop for the first few years, switching to a standard expense stop once you can accurately predict your property’s yearly operating expenses.
To Wrap It Up
One of the most important issues in the commercial real estate is probably the setting up of Base Year operating expenses, although often left unnoticed.
So, to clear off the confusion, the landlord consents on paying the tenant’s share of the operating expenses per year, but the annual exposure is equal to the first year (Base Year) amount of operating expenses. The Base Year is actually the first year of operating expenses in the lease term. Once set up, this year becomes a standard for the next couple of years to decide the additional operating expenses.
We would also recommend you to compare it with the previous years, so a copy of earlier operating expenses would be needed as well as the forthcoming estimated income.
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