Increases in outgoings over a ‘Base Year’ is a hybrid between a:
The hybrid or “semi-gross” nature of Base Year Lease says that the landlord will pay an amount each year towards outgoings, and tenants share only the cost of the increases in outgoings over that landlord contribution.
The landlord’s contribution towards outgoings will be based on an actual year of outgoings at the building - known as the ‘Base Year’. It will pay that same amount towards outgoings each year of the lease.
So, if your lease shows a ‘Base Year’, it’s important to understand how it can affect your bottom line.
Commercial outgoings are expenses that a landlord incurs in the operation, maintenance or repair of their commercial property. They're generally paid for by the tenant in addition to rent and can include:
Before a tenant signs their leasing agreement, the commercial outgoings that they'll be responsible for are negotiable and then documented in the lease contract.
Just as with most leases where there is an outgoings provision, at the commencement of each financial year, the landlord estimates the statutory and operating expenses of a building (including council rates and insurance, as well as cleaning and maintenance of common areas). At the end of each financial year, the landlord has those outgoings reconciled and independently audited (if the lease calls for it).
Under a Net Lease, the Tenant pays their proportion of outgoings based on the percentage of occupation within the building.
Under a Semi Gross Lease, the tenant pays only the increase over the base year expenses.
In both scenarios, tenants are required to share the cost of building expenses, based on their occupancy share of the premises.
Say your new lease starts 01 July 2023 and you’re leasing 20% of the available office space in the building. During the lease negotiation, you (or your wonderfully talented Tenant Rep) negotiated to only have to pay increases over the total building outgoings for the financial year ending 30 June 2022 (the ‘Base Year’). In that year, as confirmed by an auditor, the total building expenses were $200,000.
This means that you’ll be expected to pay 20% of any increase in the building’s general operating expenses over $200,000.
So, if the building’s expenses for the financial year ending 30 June 2023 are $250,000, as confirmed by an independent auditor, you’ll be required to pay to the landlord: 20% x $50,000 = $10,000.
No, they’re not.
Outgoings are expenses that the tenant has agreed to pay in addition to the rent.
Let’s keep working from the example above; our building expenses are $50,000, and we’ve negotiated to pay 20% ($10,000).
Say your rent was $100,000 in year one, and you negotiated to pay 20% of the building’s expenses ($10,000). The bill would be a total of $110,000 in the second year. However, this figure would be even more if your rent was also set to increase annually. For example, if your rent was set to increase by 4% then the total rent plus outgoings increases for year two would be $114,000.
Base year provisions are generally designed to protect landlords from significant increases in building expenses. And the calculations seem simple, right?
Wrong.
Commercial leases are never simple and poorly negotiated base calculations can potentially cost tenants thousands of dollars. Here’s what to look out for:
Commercial tenants need to keep an eye on rising variable expenses; for instance utility bills (eg. electricity), rubbish removal or property management fees.
Remember, tenants on Base Year Leases are required to pay a proportional increase of any building expenses, based on their occupancy share.
So, if you move in early to an office space in a large building that is only half occupied, you can expect the utility bills to be much lower than if the building was fully tenanted. What happens when the building starts filling up with tenants who drive up the building costs?
This process of leasing vacant space can take a while. That means that the landlord’s base year expenses might be low at the start, but the costs in subsequent years will be high once the building is fully occupied.
Let’s say the base year expenses for the partially vacant building (50% tenanted) you move into are $500,000. And, like in the previous example, you occupy 20% of the available space. As the building fills up, this bill will naturally increase. For our example, we’ll say costs increase to $800,000 at 90% occupancy.
If the building were to become 90% occupied in the second year of your lease, building operating expenses would increase by $300,000, and you’d be up for 20% of this increase because you occupy 20% of the building. That equates to an additional $60,000.
To minimise this risk, if you're looking to occupy a building experiencing high vacancy, ask the landlord to provide you with an estimate of the building's variable operating expenses at full capacity and to charge you a pro-rata share of that cost based on the percentage of the premises that you'll be occupying.
It’s also important to be aware of scenarios where a landlord can potentially profit from the base year calculation so that it works in their favour.
For instance, a landlord looking to save money on their building’s expenses can potentially defer some building repair costs so that they fall outside of the base year. That means their tenants will be liable for them in the second year.
Remember how we mentioned that operating expenses include maintenance of common areas, such as air conditioning repair? After the base year, you become partially responsible for these costs. A duplicitous landlord may deliberately delay something like air conditioning repairs, until after your base year. Where this happens, you may see a spike in operating expenses, which increases your variable costs.
Let's go back to our working example. Your company occupies 20% of a building, and you have a 2022 Base Year. Now let's say our duplicitous landlord plans to spend $800,000 on operating expenses but delays $50,000 of this spending (for air conditioning repairs) until 2023, once you've established your base year. Here's what the deferral will cost you:
$800,000 budget minus the deferred amount of $50,000 = $750,000. You pay 20% of this, which equals $150,000.
$800,000 budget plus the deferred amount of $50,000 = $850,000. You pay 20%, which means, in the second year, you're up for $170,000 (an excess of $20,000 over your base year).
What’s more, since all future increases are calculated on the purposefully lowered base year, this landlord trick will continue to cost you over your lease term.
To protect yourself, you should thoroughly audit the landlord’s operating expenses and asset maintenance records as part of the lease negotiation process and your due diligence.
It's no secret that commercial real estate leases are complicated. If they’re not negotiated correctly, they can come with a range of hidden costs that affect a tenant's bottom line. The good news is that it's a tenant's market. And getting a team of professionals on your side will protect your interests now and in the future.
Tenant CS represents commercial tenants, not landlords. So, for your next commercial lease negotiation, contact a member of our team. We’ll help you to negotiate the most favourable terms and conditions and better understand commercial lease structures, such as base year expense calculations, to minimise your risks and costs.
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