Once a year, typically during the 1st quarter, tenants with full-service commercial real estate leases that include pass-through expenses will receive an Operating Expense statement from their landlord.
The operating expense statement will reflect the tenant’s obligation to pay its share of increases in the operational costs of the building.
Here’s a basic explanation of operating expenses and how they affect tenants. The vast majority of multi-tenanted office buildings are leased on a full-service basis. Full-service means that all of the expenses associated with operating a building are included in the rental rate.
These expenses include:
- Property Taxes
- Building Maintenance
- Property Repairs
- Janitorial Service
A tenant engaged in commercial real estate leasing can expect that every cost associated with their lease will be taken care of, even down to a burned-out light bulb. You can imagine that over the course of a long-term lease, increases in building operating expenses, due to inflation, will eat away at the building owner’s profit margin.
In order for landlord’s to keep their rental income somewhat steady, the base year method has gained popularity and appears in most full-service commercial leases. The base year concept is fairly simple – the first year a tenant occupies their space is usually set as the base year. Until December 31 of your base year, all of the expenses associated with your lease will be fully covered by the landlord. A dollar figure will be calculated reflecting the precise cost per square foot of the building expenses.
So what happens during your second year of occupancy in a building? Your rent will still cover the building expenses that actually occurred during your base year, but any increases in building expenses will be passed through to you in the form of a separate bill. The landlord, or their property management company, will send you a reconciliation statement showing the total of the additional charges.
Tenants are often concerned about whether increases have been properly calculated and whether some costs have been improperly included. At the very minimum, you should refer to your commercial real estate lease and compare the cost items in the reconciliation statement with the language of the operating escalation clause contained in your lease. During the lease negotiation process, many tenants go to great lengths to insure that items included as building operating expenses are typical for the type of building and that they are applied fairly among the tenant base.
Don’t lose this advantage by neglecting to verify the base year reconciliation report against the terms of your lease.