Understanding the terms of a commercial real estate lease can quickly become a challenging task. One lease term that people often find confusing is the expense stop. In this post we discuss what an expense stop is, how an expense stop is typically used, and then walk through an example to bring it all together.
What is an Expense Stop?
According to the CCIM Institute, the definition of an expense stop is:
The level (or maximum amount) up to which the landlord will pay certain operating expenses. Amounts above the expense stop are the tenant’s responsibility.
An expense stop is a tool used by landlords to limit their exposure to operating costs, and as such helps to maintain predictable operating expenses over the term of a lease.
How Does an Expense Stop Work?
Let’s run through a quick example of how expense stops work in practice. Let’s say we’re looking at a 10,000 square foot office building with 2 tenants occupying 5,000 square feet each. Each tenant signs a lease for $25 per square foot with all expenses passed through to the owner, up to $7 per square foot or $70,000 per year.
Suppose operating expenses actually turn out to be $100,000 per year. That means that the tenants would be required to pay $30,000 towards operating expenses, while the landlord’s out of pocket cost would be limited to $70,000. Normally in multi-tenant buildings, each tenant is only responsible for their pro-rata share of operating expenses above the expense stop. So, in this case, each tenant would only have an out of pocket obligation of $15,000.
“Base year” expense stops are also common. With a base year expense stop the landlord pays all of the first year operating expenses for a tenant, and then in subsequent years the tenant is responsible for any expenses in excess of the base year amount. The portion of expenses above the expense stop that are passed through to the tenant are commonly referred to as “Recaptured” or “Recovered” expenses.