Lease Tips

Prepare Your Budgets Properly

When preparing budgets, it is imperative to realize that a tenant's liability for its share of increased operating expenses can rise at a completely different (and much higher) rate than the building's expenses.  Although building operating costs may inch up by only 3-4% per year, your liability will usually more than double the first year and rise thereafter by around 50%, 33.3%, 25%, and so on. 
  

How can this be?  It’s simple math.  In leases with base years and expense stops, the tenant is obligated to pay only for increases over the base costs.  The increases change much more drastically than the expenses themselves. 

Let’s see how this works:

Building pass-throughs can rise at a completely different (and much higher) rate than the actual operating expenses.


Assume a tenant signs a new lease with a 2005 base year, and that the tenant is obligated to pay for 10% (its pro rata share) of increases over that amount.  If the 2005 base year costs turn out to be $500,000, and are expected to rise in 2006 by 4%, they should reach $520,000 that year.  In planning for 2006 costs, the tenant should budget for 10% of the $20,000 increase, or $2,000. 

In 2007, the following year, if building costs are expected to rise by another 4%, they will rise by $20,800 to $540,800.  The tenant, who is already paying $2,000, will now have to pay $4,080 instead.  The change from $2,000 to $4,080 is 104%, a far cry from the 4% increase in the building's expense levels.

Similarly, in 2008, if costs rise by another 4%, they will rise by $21,632, and the tenant will have to increase its $4,080 payment by another $2,163.  This is a 53% increase over the prior year’s amount.   

This concept applies to all escalations with base years or expenses stops.  It is not in any way unfair; it is simply because the annual percentage change in a tenant's escalation (a relatively small number) is much greater than the percentage change experienced by the building's expenses as a whole (a much larger number).  

When planning for the ongoing costs of a lease, remember to project out the anticipated cost increases based on these principles, and to explain that these are not unusual increases but are inherent in the lease structure.

ABOUT KBA LEASE SERVICES

KBA Lease Services specializes in controlling corporate real estate lease costs through lease auditing.  Formed in 1985, KBA (formerly Kislak Lease Services) pioneered the lease audit industry.  KBA has reviewed tens of thousands of leases and saved many millions of dollars for its clients.

Visual Lease® is KBA’s powerful, easy-to-use lease management software system.  Visual Lease has proven, for the past seven years, to be the best designed system on the market.  It is powerful enough to manage the most complex lease administration tasks, yet easy enough for novices to use.

CONTACT INFORMATION
Marc Betesh, Esq., MCR.h
President
888.876.6500 ext. 400
 mbetesh@kbalease.com 

Anthony M. Beja
Vice President, Sales and Marketing
888.876.6500 ext. 430
abeja@kbalease.com

 

©2008 2006 KBA Lease Services, LLC. All rights reserved. No reprints of this article may be made without the written permission of KBA Lease Services, LLC.