Expense stops allow the owner to pay a portion of the operating expenses up to a specified amount, usually based on a price per square foot (psf). Excesses of the expense stop are then passed through to the tenant based on the amount of rentable building space the tenant is occupying.
Here’s an example: A lease for an office may contain a clause that states the tenant will pay $20 per square foot per year in rent and that the owner will pay all operating expenses associated with the property – as long as the expenses do not exceed $8 per square foot of the rentable area.
If the building has 50,000 square feet of rentable area, with this clause the owner is required to pay the first $400,000 in annual operating expenses ($8 per square foot X 50,000 square feet). If there are any additional expenses required to operate the building that exceed $400,000, the tenant will be charged the overage based on the percentage of the building’s rentable area or the square footage that the tenant occupies.
This then limits – or stops – the owner’s operating expenses at $400,000. To further illustrate this: if the operating costs of this property are $440,000 annually, using the example above the tenant could an additional $.80 per sq ft ($40,000/50,000) on the annual rental rate of $20 per sq ft.
So, if a tenant leases 10,000 sq ft of office space in this building at the rental rate of $20 per sq ft (10,000 X $20), the tenant will pay the landlord $200,000 per year, or $16,666.66 per month. In this example, when operating expense overages are incurred at $.80 per sq ft, this 10,000 sq ft tenant will pay an additional $8,000 at a time(s) specified in the lease contract.
Expense stops typically benefit owners by limiting their risk exposure to operating expenses being greater then expected. These stops also allow owners to forecast operating costs based on predictable expenses.