Just because you have a full service or gross lease does not necessarily mean that you are shielded from exposure to an escalation for operating expenses. Many owners protect themselves by adding base year provisions to their leases and by raising the reimbursement portion of the full service lease when expenses exceed those in the base year.
How Base Years Work
If you read the fine print on your full service or gross lease, you might find out that your monthly rent payment actually has two pieces -- a piece that corresponds to a rental charge and a piece that reimburses the building's operating expenses. For instance, your $36 per square foot gross rent might actually be made up of two pieces -- $25 in rent and $11 in expenses.
Let's imagine that the year that you signed your lease, the building's actual expenses were $11 per square foot. If your lease had a base year escalation clause -- and it probably does -- and expenses went up to $11.50 in the next year, your rent would go up to $36.50 per square foot. That $36.50 would break down as $25 in rent and $11.50 in expenses, since the rent went up to 50 cents over the level set in the base year (usually the first year you signed your lease).
Here's the tricky thing about a base year escalation: it can happen in addition to regular rent escalations. For instance, if your lease has annual $1 increases, the rent portion would go from $25 to $26. However, if operating expenses also went up, that portion would increase. So, if those increased to $11.75 per square foot, your new rental rate would be $37.75 -- $26 in rent and $11.75 in expenses.
Predicting Next Year's Escalation
Without a crystal ball, it's hard to predict exactly what next year's operating expenses will be, but you can make an approximation. The easiest way to do this is to ask your landlord for a history of your building's operating expenses. If they typically go up by 3 or so percent a year, you can assume that you will probably face an escalation of 3 or so percent every year. In fact, this is typical.
If you really want to be able to predict your future, pay careful attention to your building and what is going on around it. A year with a harsh winter could lead to higher expenses as landlords pay more for energy for heating and for plowing services. If taxes go up in your community, your building will probably get reassessed at a higher level -- and charge you more. Conversely, if natural gas prices drop, you could end up with lower expenses.
Controlling Exposure to Escalations
Once you have a base year escalation clause in your lease, you are subject to its terms. Before you sign that lease, though, you are in a stronger position to negotiate. You might be able to cap base year increases to a reasonable percentage. Another strategy could be to sign your lease in one year (like 2015) but have the base year be expenses incurred in the future (like 2017). This will give you a couple of years of stability and limit your risk. Your tenant representative can help you devise a strategy that gets you the right space today on terms that limit your exposure in the future.
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