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Whether you’re an owner/landlord, real estate agent or even a tenant, knowing what a base year clause is in a rental agreement is invaluable.
A base year clause is used in negotiations for full service or modified gross leases, which means the tenant will be responsible for any increases to operating expenses above the first year (base year). The main operating expenses are property taxes, property insurance and common area maintenance costs.
Under this agreement, the owner or landlord pays the first year of operating expenses, known as the base year. Whatever the operating cost is in the base year is the set amount the landlord will pay going forward.
Advantages of Base Year
As an owner or landlord, including a base year clause in your rental agreement could be a financially prudent decision.
For instance, if your operating cost is $100,000 in the base year, but then $120,000 in the second year of the agreement, the tenants — not you — will be responsible for paying their pro rata share of the additional $20,000.
If an owner knows they have upcoming maintenance expenses, they could go the base year route and defer those expenses to year two to lessen their own operating cost.
“To do this, you really must have a good handle on what the operating expenses are or are going to be,” said a Beck Partners Sales Associate, Chris Cobb.
From a tenant’s perspective, there are ways to place caps on these operating increases. For example, a tenant could agree to the base year arrangement but decide they’ll only be responsible for up to a 5% increase beyond the first year’s cost.
Owners of new buildings might reap the most reward from a base year agreement.
“If you’re in a new building, the operating expenses are typically lower in the first year than they would be in a steady state year,” Chris explained. “That’s because everything is new and less likely to break. If it does break, chances are it’s covered by the warranty. Typically, the warranty on a lot of items in a building that could break have a one-year warranty after they’re built. Really, you would see a big jump in the operating expenses of a new building after the first year.”
Many people confuse base year with base rent in a typical rental agreement. Base rent is simply the tenant’s cost of rent, and everything above that line consists of the operating expenses, taxes, insurance, maintenance, utilities, etc.
Another misconception when it comes to base year is what entails an operating expense versus what entails a capital improvement, which usually doesn’t fall under the umbrella of a base year clause. Capital improvements are usually significant renovation items, such as replacing an air conditioning unit or painting the entire space.
“In addition to the base year, you also want to pay attention to how the rental agreement defines operating expenses,” Chris said.
Beck Can Assist
Beck Partners has experts, like Chris Cobb, who are well-versed in the nuances of base year clauses. Whether you’re an owner, a regional or national broker, Beck has the insights and resources to assist you in all of your base year needs.