Expense gross-up
Also called Gross-up provision, Grossing up operating expenses.
A gross-up provision restates a building's variable operating expenses to what they would have been at a stated occupancy, usually 95 or 100 percent, before recoveries are calculated. It exists so that a tenant's reimbursement measures expense inflation rather than how full the building happened to be.
How it works
The problem it solves is mechanical. Variable expenses such as cleaning, utilities and the management fee move with occupancy, so a half-empty building spends less on them. Without a gross-up, a tenant whose base year fell during a vacant stretch gets an artificially low stop and then pays large reimbursements as the building fills, none of which is inflation and all of which the tenant will eventually notice.
Applied inconsistently it makes the problem worse rather than better. The base year is grossed up and every comparison year is grossed up, to the same stated occupancy, across the same list of variable expenses. Grossing up the comparison year alone raises the tenant's bill; grossing up the base year alone lowers it. The lease should name the occupancy standard and should say which expenses count as variable, because that list is negotiated and real estate taxes, insurance and structural items generally are not variable at all.
It also protects the landlord in the direction people forget. In a partly leased building, grossing up lets each occupied tenant be billed its share of what a full building would spend, so the landlord absorbs only the genuinely vacant share instead of subsidizing the occupied tenants as well. That is why the clause appears in triple net and modified gross leases and not only in base-year office.
Formula
Grossed-up variable expense = actual variable expense x (gross-up occupancy / actual occupancy)- Only variable expenses are grossed up. Real estate taxes, insurance and structural maintenance are fixed and are not
- The standard is named in the lease, most commonly 95 percent and sometimes 100 percent
- The same standard has to be applied to the base year and to every year compared against it
Worked example
Illustrative. An 8,000 square foot suite. Base year expenses of $12.50 per square foot with the building 80 percent occupied, of which $4.00 was variable. By year three the building is 95 percent occupied and expenses are $13.78 per square foot. The lease grosses up to 95 percent.
| Base year expenses as incurred | $12.50 per sq ft |
|---|---|
| Variable component grossed up to 95%4.00 x 95 / 80 | $4.75 per sq ft |
| Base year stop after the gross-up | $13.25 per sq ft |
| Year three expenses, building now 95% occupied | $13.78 per sq ft |
| Reimbursement against the ungrossed stop | $10,250 |
| Reimbursement against the grossed-up stop | $4,250 |
Six thousand dollars of the ungrossed bill on one suite is the building filling up rather than expenses rising. Across a 180,000 square foot building the same error is roughly $135,000 a year of recovery income that will not survive the first tenant audit.
Conventions worth knowing
- Ask which expenses the lease treats as variable. A clause that grosses up the whole expense stack, taxes included, is drafted wrong and will be challenged.
- A lease with no gross-up provision and a base year set during a lease-up is worth more to the landlord, and it is exactly what a tenant's counsel looks for.
The common mistake
Grossing up the comparison year and not the base year
It is the natural way to build the model, because the current year's occupancy is the number in front of you, and it produces recovery income that is too high for the whole term. The tenant's stop stays at the depressed base-year level while every later year is restated upward, so the reimbursement captures the occupancy recovery as well as the inflation. It is also the first thing a tenant audit finds. Gross up both sides to the same stated occupancy, and if the lease does not permit the base year to be grossed up, do not gross up the comparison year either.
Related terms
- Expense stop and base yearIn a gross or modified gross lease, an expense stop is the level of operating expenses the landlord absorbs, with the tenant reimbursing everything above it. A base year stop sets that level equal to the actual operating expenses in the lease's first calendar year.
- Triple net and expense recoveriesUnder a triple net lease the tenant pays base rent plus its share of the property's taxes, insurance and common area maintenance. Expense recoveries are the mechanism that bills those costs back, normally as a pro rata share based on the tenant's proportion of the building's leasable area.
- Operating expense ratioThe operating expense ratio is total operating expenses divided by effective gross income. It is a fast sanity check on whether an expense budget is plausible for the asset type, the market and the way the property is run.
- Renewal probabilityRenewal probability is the assumed chance that an expiring tenant stays rather than leaves, applied lease by lease. It blends the two very different outcomes of an expiration into one expected cash flow, and it is usually the single most valuable assumption in an office, retail or industrial model.
- Lease rolloverLease rollover is what happens when a lease expires: the tenant renews, or leaves and the space sits empty until a new tenant is found and fitted out. Modeling it means applying a renewal probability, downtime, leasing capital and a new market rent to every expiring lease.
Every figure, traced to its source
Altyst computes these in exact decimal arithmetic, not with a language model, and clicking any number shows the formula behind it.