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?

Our Commercial Leasing Glossary defines an Expense Stop as:

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.

base year

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.

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13 Responses to What the heck is an Expense Stop?

  1. The Tenant Advocate (@BenjaminOsgood) says:

    Great graph, Dominic! A picture is worth a thousand words – I’ll be forwarding along this post to a few of my clients :)

  2. Howard Kline says:

    Good article and graphic. Done well.

  3. Josef Farrar says:

    Tenants should avoid a expense stop and insist on a Lease Base Year well defined in the lease.

  4. Hi Dominic, Great illustration on the expense stop. So many people get confused about this. I have a few examples of negotiating caps on operating expenses here: http://www.austintenantadvisors.com/blog/how-to-negotiate-operating-expense-caps-when-leasing-office-space/

  5. Thanks Dominic, This is my first time hearing the term; Now I know! 😀

  6. Dave Cattell says:

    Thanks Dominic, clear explanation, well done!

  7. In Retail, typically we have NNN charges, they are CAM – Common Area Maintenance, Taxes – Real Estate Taxes and Insurance. All are apportioned based on actual Sq. Ft. In example $5.50 NNN for a 2,000 Sq. Ft. Location.
    $11,000.00 Annually or $916.67 Per Month which is how it get paid. What you need to do is have any overage and or reporting by Landlord be transparent to the tenant. A stop can come in for overages above the NNN. However, they will still get passed on. In example, assume we have a very bad winter, snow removal in the proforma or estimate in CAM was for $.38 Per Sq. Ft. But it actually comes in at $.52 Per Sq. Ft. then based on this the LL will pass along actual overage to the tenant, in this case that would be an extra $23.00 Per month. The key for all tenants and this is where your experienced Tenant Rep. broker comes in is that they will insist on this being illustrated in the LOI. Then those business terms contained within the four corners of the lease.
    The Larger the tenant, the more Sq. Ft. they are taking the more leverage they will have conducting negotiations. Looking at 47,000 Sq. Ft. Grocery store compared to your 2,000 Sq. Ft. Location is a different as day and night. That is where you will see stops, not to exceed a specific point. Usually the leverage will be in CAM, not with RE taxes or insurance.

  8. Dominic, your article mentions using the right to audit as a precaution (or check & balance) against Base Year stop manipulation. As a lease professional auditor for more than 20 years, I can attest to the importance of negotiating good (unfettered) lease audit rights to review the Base Year. If any item is undercharged in the Base Year, the tenant may pay dearly for it in every subsequent year. For example, if the Base Year of a ten year lease only has charges for eleven months of janitorial service because the landlord neglected to accrue for one month, then the tenant could be overcharged on janitorial for the next nine years!

    Separately, prior to signing the lease, the tenant (or their broker) should understand the building’s vacancy rate in the Base Year and model how changes in vacant space could impact subsequent years’ operating expenses and real estate taxes. If appropriate, insert a good gross-up clause in the lease. MANY tenants do not understand what a gross-up clause is and how it works. Every year, our lease audit firm has dozens of cases in which we discover that the landlord’s gross-up methodology is flawed and we are able to recover tenant overcharges.

  9. Bonnie Farmer says:

    If a Base Year is higher than future years, does a tenant get a CREDIT – say base year 2013 is 100k and year 2014 expenses come to 75k – is the difference credited or only if the future years are HIGHER than base year?

  10. […] says this: “An explicitly stated expense stop avoids the need for a tenant to be concerned about how […]