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Expense Stops in Commercial Real Estate
In a full service gross lease, the tenant pays a base rental rate, and landlord is typically responsible for paying any additional expenses (such as CAM fees), except for those that go above a specific amount, called an expense stop. Any expenses that exceed the expense stop then become the responsibility of the tenant.
What is an Expense Stop in Commercial Real Estate?
In a full service gross lease, the tenant pays a base rental rate and the landlord is typically responsible for paying any additional expenses (such as CAM fees). The exception is those above a specific amount, called an expense stop. Any expenses that exceed the expense stop then become the responsibility of the tenant. In essence, the expense stop is the most a landlord will pay for expenses in any given year.
How Expenses Stops Actually Work
In many cases, expense stops are set a certain amount of operating expenses per square foot. For example, if the expense stop for an office property is set at $5/sq. ft., and operating expenses per sq. ft. are $7/sq. ft., a tenant would be responsible for paying the difference of $2/sq. ft (on their share of the property).
For instance, in the example above, if the office building had 15,000 sq. ft. and 3 tenants, one using 10,000 sq. ft., and the other two using 2,500 sq. ft., the tenants are responsible for paying for anything more than $75,000 a year in operating expenses ($5/sq. ft. * 15,000 sq. ft.).
If operating expenses that year reach $105,000 ($7/sq. ft. * 15,000 sq. ft.), the tenants are responsible for paying the $30,000 difference. The tenant occupying 10,000 sq. ft. pays $20,000, while the other two tenants occupying 2,500 sq. ft. pay $5,000 each.
Base Year Stops Also Help Landlords Limit Their Risk Exposure
In other situations, expense stops are set at a base year stop-- the actual operating expenses in the first year of the lease. In essence, the tenant doesn’t pay any additional operating expenses in the first year, but if expenses rise beyond that amount in subsequent years, they will be responsible for paying. By doing this, a building owner/developer ensures that their operational expenditures (OpEx), do not increase past the first year of leasing, allowing them to cut costs and improve the project's financial stability.
Sometimes in their lease agreement, a tenant requests an annual audit of their landlord’s operating expenses. They do this to ensure that they're not being taken advantage of. This is typically more common with larger tenants who have more negotiating power.
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Related Questions
What are the most common expense stops in commercial real estate?
The most common expense stops in commercial real estate are typically set at a certain amount of operating expenses per square foot. For example, a common expense stop for an office property is set at $5/sq. ft. This means that if the operating expenses per sq. ft. are $7/sq. ft., the tenant would be responsible for paying the difference of $2/sq. ft. (on their share of the property).
In addition, expense stops can also be set as a total amount for the entire property. For instance, if the expense stop for an office property is set at $75,000 a year in operating expenses, the tenants would be responsible for paying for anything more than $75,000 a year in operating expenses.
It is important to note that expense stops can vary depending on the type of property and the terms of the lease agreement. It is best to consult with a commercial real estate financing advisor to determine the best expense stop for your particular situation.
What are the benefits of having expense stops in commercial real estate?
The main benefit of having expense stops in commercial real estate is that it helps landlords limit their risk exposure. By setting an expense stop at a base year stop, the tenant doesn't pay any additional operating expenses in the first year. This allows the building owner/developer to cut costs and improve the project's financial stability. Additionally, expense stops can be set at a certain amount of operating expenses per square foot, which can help tenants ensure that they are not being taken advantage of.
What are the risks associated with expense stops in commercial real estate?
Expense stops in commercial real estate can be beneficial for both landlords and tenants, but there are some risks associated with them. For landlords, the risk is that operating expenses may exceed the expense stop amount, leaving them responsible for the difference. This can be especially risky if the tenant requests an annual audit of the landlord's operating expenses. For tenants, the risk is that they may be responsible for paying more than they expected in operating expenses if the expense stop is set too low.
How can expense stops help protect a commercial real estate investor?
Expense stops can help protect a commercial real estate investor by limiting their risk exposure. By setting an expense stop at a base year stop, the tenant doesn't pay any additional operating expenses in the first year, but if expenses rise beyond that amount in subsequent years, they will be responsible for paying. This allows the building owner/developer to cut costs and improve the project's financial stability.
In addition, tenants may request an annual audit of their landlord’s operating expenses to ensure that they're not being taken advantage of. This is typically more common with larger tenants who have more negotiating power.
Expense stops can also be set at a certain amount of operating expenses per square foot. For example, if the expense stop for an office property is set at $5/sq. ft., and operating expenses per sq. ft. are $7/sq. ft., a tenant would be responsible for paying the difference of $2/sq. ft (on their share of the property).
What are the best practices for setting up expense stops in commercial real estate?
The best practices for setting up expense stops in commercial real estate depend on the situation. Generally, expense stops are set at a certain amount of operating expenses per square foot. This allows the tenant to be responsible for any additional operating expenses beyond the set amount. Additionally, tenants may request an annual audit of their landlord’s operating expenses to ensure they are not being taken advantage of.
In other situations, expense stops are set at a base year stop-- the actual operating expenses in the first year of the lease. This allows the building owner/developer to ensure that their operational expenditures do not increase past the first year of leasing, allowing them to cut costs and improve the project's financial stability.
For more information, please visit www.commercialrealestate.loans/commercial-real-estate-glossary/expense-stop.