Gross-ups are adjustments to a building’s expenses to bring them up to what they would be were the building fully operational.

Many leases require landlords to gross up building operating expenses as part of the calculation of tenant pass-throughs. This article will explore why gross-ups are used and how they are calculated.

Why Are Gross-Ups Necessary?

Gross-ups enable operating expense pass-throughs to conform to their underlying purpose.

• Building services are not individualized:  Tenants are often required to reimburse the landlord for the tenant’s fair share of building expenses. However, services are not rendered to tenants individually; they are rendered to the building as a whole.  Similarly, costs are not isolated for each individual tenant; they are aggregated for the building as a whole.  They are then divided among the tenants according to their respective shares of the building.
• Building vacancy dilutes the expense total:  Building vacancy reduces expenses that vary with occupancy (such as cleaning, utilities, maintenance, and supplies).  Because tenants’ costs are calculated based on their share of the entire building, tenants end up paying a share of a reduced expense level.  As a result, the landlord may not receive the full expense reimbursement it is expecting.

Grossing Up a Base Year

Vacancy in a Base Year causes recurring tenant overcharges.  Vacancy can create an inequity against the tenant when it occurs in a base year.  In many leases, the tenant is obligated to pay for increases in costs over what they were in an agreed-upon base year.  If the building has vacancy in that year, building expenses will be abnormally low, resulting in overstated increases in later years.  

This is a serious problem for tenants because a low base year will result in overstated increases for every subsequent year of the lease.

Grossing up base year fixes the problem.  It results in the tenant paying for the expected increases in expenses.

Fixed vs. Variable Expenses

Not all expenses vary in direct proportion to occupancy:  Many have a fixed component—a part that is unaffected by occupancy.

• Lobby and common areas must be cleaned regardless of occupancy levels
• Tenant areas must be minimally heated and ventilated even when they are vacant

Each expense must be examined closely to determine the correct gross-up result.