Have you ever been asked “What the heck is an Expense Stop?!” Folks who lease commercial space on a regular basis know exactly what it is, but how do you explain the concept to someone who doesn’t?
A fixed amount (typically per square foot) in a lease where the tenant is responsible for all building operating expenses and taxes in excess of said amount.
What is the purpose of an Expense Stop?
Expense stops benefit landlords by limiting exposure to operating expenses being greater than expected during the course of a lease. In other words, many landlords look to incorporate some type of Expense Stop into Full Service leases because it protects their operating income. For instance, when the property’s expenses increase over the life of a tenant’s lease term, the landlord is then able to bill the tenant for those increases, rather than absorb them on their own.
Let’s look at a more concrete example; consider a lease that has a $5.00/sf Expense Stop.
In the example above, the Expense Stop is equal to the first year’s Operating Expenses. Because the Operating Expenses are less than (or equal to in this case) the tenant’s Expense Stop, the tenant is not required to reimburse the landlord for any overages.
Then, in years 2 through 10, the property’s operating expenses exceed the Expense Stop. The chart includes the landlord’s operating expense responsibility in Green and the tenant’s expense reimbursement amount in Red. Notice how the landlord is able to limit exposure to future inflation in operating expenses. As the chart shows, the tenant is responsible for reimbursing the landlord for the increases over and above this $5.00/sf Expense Stop.
Is a Base Year Stop different than an Expense Stop?
A Base Year Stop is a certain type of Expense Stop. The difference between an Expense Stop and a Base Year Stop is that an Expense Stop’s value is a predetermined dollar amount, whereas a Base Year Stop is calculated on a calendar year basis or the first 12 months of a tenant’s occupancy. Using a Base Year Stop, rather than an explicit Expense Stop has several implications:
1. A Base Year Stop is derived directly from the property’s operating history, whereas an Expense Stop is can be arbitrarily set. For this reason, a Base Year Stop establishes a more accurate starting point to benchmark future operating expense increases.
2. The downside of a Base Year Stop is that the landlord has some level of control (i.e. ability to manipulate) during the period which the Base Year Stop is being established. Because of this, many tenants insist on including certain checks and balances within their Base Year Stop clause. The most popular precaution is to the right to audit the landlord’s operating expense ledger and expense reconciliation calculations once a year.
3. An explicitly stated Expense Stop avoids the need for a tenant to be concerned about how the Base Year Stop is established, but it is important to validate that any Expense Stop used is a realistic starting point from which to benchmark future expense increases. If the Expense Stop is artificially low, the tenant risks being exposed to larger than expected reimbursement billings from the landlord.
Any qualified tenant rep broker will be well versed in the nuances of Expense Stops, contact us should you need a recommendation or referral for your market.