Expense stop and base year
Also called Base year stop, Expense stop.
In 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.
How it works
The structure exists to solve a real problem with gross leases: a landlord quoting one all-in rent takes the entire risk of expense inflation for the term. A stop caps that exposure at a fixed dollar amount per square foot, and everything above it flows through to the tenant.
A base year stop is the version most commonly used in office. It is easy to negotiate because no one has to agree a number in advance, and it is harder to model because the number is not known until the year is over. It also resets: a tenant signing a new lease in year six gets a new base year at year six expense levels, which wipes out all accumulated recovery from that suite. Every renewal in an office model has to reset the stop, and models that carry the original stop forward overstate recoveries for the rest of the hold.
The details that get negotiated are worth reading. A gross-up provision restates variable expenses to what they would have been at full occupancy, which protects the landlord from setting a base year during a period of low occupancy. Caps on controllable expenses limit annual increases, often to 4 or 5 percent, and exclude taxes and insurance. Each of these changes the recovery arithmetic materially.
Formula
Tenant reimbursement = (current year operating expenses per square foot - stop per square foot) x tenant area- A negative result is normally zero, not a payment from landlord to tenant
- Base year expenses should be grossed up to a stated occupancy, commonly 95 percent, if the lease allows it
- A new lease or a renewal typically resets the base year, eliminating the accumulated recovery from that suite
Worked example
Illustrative. 8,000 square foot suite. Base year operating expenses $12.50 per square foot. Expenses grow 5 percent a year.
| Year three expenses | $13.78 per sq ft |
|---|---|
| Year three reimbursement | $10,250 |
| Year five expenses | $15.19 per sq ft |
| Year five reimbursement before renewal | $21,551 |
| Tenant renews in year six, base year resets to $15.95 | |
| Year six reimbursement after the reset | $0 |
Five years of accumulated recovery vanishes at renewal. On a building with staggered expirations this happens continuously, and a model that does not reset base years on renewal will overstate recovery income every single year.
The common mistake
Carrying the original base year through the whole hold
It is easy to set a stop once and let recoveries compound against it for ten years, and the resulting income is entirely fictional for any suite that renewed. Every renewal resets the base year to that year's expenses. The correct model tracks a stop per lease, resets it on renewal or on a new lease, and grows expenses against each suite's own base. This is one of the most common overstatements in office underwriting because the error grows quietly with every year of the model.
Related terms
- 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.
- 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. Modelling it means applying a renewal probability, downtime, leasing capital and a new market rent to every expiring lease.
- 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.
- Tenant improvements and leasing commissionsTenant improvements are the landlord's contribution to fitting out a space for a tenant, quoted per square foot. Leasing commissions are the brokerage fees paid on a signed lease, quoted as a percentage of the rent over the term. Together they are the cost of putting a tenant in place, and they are capital, not operating expense.
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.