Chapter 11

Question 1

What is an operating expense escalation?

Answer 1

It is a clause that provides for reimbursement of increases in the owner’s cost of operating the property,

Question 2

Why are the operating expense escalations necessary?

Answer 2

They allow the owner to recoup increased costs of running the building due to inflation and other factors.

Question 3

Describe a net lease.

Answer 3

A type of lease that requires tenants to pay debt service, profit, repairs, and insurance to the lessor. The tenant pays property taxes separately.

Question 4

Describe a double net lease.

Answer 4

A type of lease that requires the tenant to pay debt service, profit, and repairs to the lessor. The tenant pays insurance and property taxes separately.

Question 5

Describe a triple net lease.

Answer 5

A lease that requires tenants to pay separately for their share of all building expenses. Rental payments cover only debt service and profit.

Question 6

Why are expense classifications important?

Answer 6

They allow us to identify expenses that can be passed on to the tenant.

Question 7

What are the typical common expense categories?

Answer 7

Real property taxes
Operating expenses
Common area maintenance

Question 8

Describe Common Area Maintenance (CAM) charges.

Answer 8

The expenses incurred to maintain the sidewalks, parking lots, landscaping, and other common areas of the property.

Question 9

What is a modified gross lease?

Answer 9

A lease requiring the tenant top pay for operating expenses over a pre-established amount.

Question 10

What is an expense stop?

Answer 10

(also called base amount)

A set amount of operating expenses paid by the landlord.

Question 11

What is a gross lease?

Answer 11

A lease with base rent only.

Question 12

What is the formula for calculating the tenants share of cost increases?

Answer 12

tenant’s share=(Escalatable Cost Pool-Base Amount)*tenant’s pro rata share

Question 13

Define escalatable costs.

Answer 13

The expenses identified from the building operating costs that can increase.

Question 14

Why is it important that each expense account category contain 12 full months of activity?

Answer 14

When using the cash basis method of accounting, having 12 full months of activity for each account can be said to reasonably conform to the accrual accounting requirements.

Question 15

List several typical expenses that are excluded from the escalatable cost pool.

Answer 15

leasing commissions
depreciation
professional fees
advertising
franchise and income taxes
interest and amortization of debt service
legal fees
capital expenses
building improvements
tenant improvements
non-operating owner expenses
reimbursed operating expenses
ground rents

Question 16

Why do many leases provide the tenant with the right to audit the books and records of the landlord?

Answer 16

It allows the tenant to verify that the landlord has applied proper account treatment for all expenses included in the escalatable cost pool.

Question 17

Define pro rata share.

Answer 17

The portion of the escalatable cost pool the tenant pays when not occupying 100% of the building.

Question 18

What is the most common pro rata share calculation?

Answer 18

pro rata=tenant’s rented square footage/total rentable square footage

Question 19

What is the difference between a base year and an expense stop?

Answer 19

A base year is the typical operating expenses from a typical year while an expense stop is a predetermined amount.

Question 20

What is a cap?

Answer 20

It is a limit on the amount of increase in any one year, usually expressed as a percentage

Question 21

How should escalation charges be communicated to the tenant?

Answer 21

Delicately and providing as much detail for the escalations as possible to help them understand the reason for extra charges.
It may be helpful to have an independent auditor complete an audit of escalatable charges prior to communicating with the tenant.

Question 22

What is a Consumer Price Index (CPI) increase?

Answer 22

An increase in base rent to account for inflation based on changes to the CPI.

Question 23

What are base index and an anniversary index?

Answer 23

A base index is the value of a dollar of rent adjusted for inflation using the CPI during the month of lease commencement.
An anniversary index is the value of a dollar of rent adjusted for inflation using the CPI on each lease anniversary date.

Question 24

What is the purpose of percentage rent?

Answer 24

It encourages the owner to participate in the success of retail tenants and helps them to recoup the cost costs of advertising to drive business to the retailer.

Question 25

What is a kick-out clause?

Answer 25

It is a clause that allows the landlord to terminate a lease when the tenant does not reach an agreed upon sales level after a period of time.

Question 26

What is a triple net lease?

Answer 26

It is a lease requiring the tenant to pay for his share of building operating expenses such as real estate taxes, operating expenses, and insurance

Question 27

What is the basic calculation for figuring a tenant’s share of a cost increase?

Answer 27

tenant’s share=(escalatable cost pool-base amount)*tenant’s pro rata share

Question 28

How are pro rata shares determined?

Answer 28

They are stated in the rent as either a percentage or a calculation will be defined in the lease.
pro rata=tenant’s occupied square footage/total rental square footage.

Question 29

Explain how to calculate a CPI increase.

Answer 29

The annual increase percentage is usually some fraction of CPI increase.
Increases are determined by comparing anniversary CPI index to base CPI index

Question 30

Costs are typically accumulated into which major categories for additional rent purposes?

a) taxes, utilities, operating expenses
b) taxes, operating expenses, common area maintenance charges
c) taxes, insurance, non-operating expenses
d) taxes, utilities, common area maintenance charges

Answer 30

b) taxes, operating expenses, common area maintenance charges

Question 31

Which lease format requires the tenant to share in all costs of operating the building?

a) triple net
b) modified gross
c) gross
d) single net

Answer 31

a) triple net

Question 32

Base amounts are stated in which lease type?

a) triple net
b) modified gross
c) gross
d) single net

Answer 32

b) modified gross

Question 33

Operating expenses for the current year are $2,227,486. The tenant’s base year operating expenses are $2,036,895. The tenant’s pro rata share is 13.56%. What is their annual additional rent for operating expense escalations?

a) $2,153.68
b) $25,844.00
c) $190,591.00
d) $2,227,486.00

Answer 33

b) 25,844.00

Question 34

The tenant’s annual base rent is $240,000. The CPI index for the base year is 158.5 and the CPI index for the current year for the current year is 165.7. What is the tenant’s annual additional rent for 100% of the CPI increase?

a) $1,440
b) $10,428
c) $10,896
d) $17,280

Answer 34

c) $10,896

(annual CPI index-base index)/base index to two decimal point* base rent

Question 35

Most escalation charges are:

a) charged quarterly
b) spread out over a twelve month period
c) charged at the end of the lease term
d) taken out of the security deposit

Answer 35

b) spread out over a twelve month period

Question 36

A tenant pro rata share is typically calculated by dividing the:

a) building’s square footage by the tenant’s square footage
b) tenant’s usable square footage by the building’s usable square footage
c) tenant’s gross square footage by the building’s gross square footage
d) tenant’s rentable square footage by the building’s rentable square footage

Answer 36

d) tenant’s rentable square footage by the building’s rentable square footage

Question 37

The owner’s mechanism to maintain the equity value of the base rent dollar is known as:

a) CPI increase
b) interest charges
c) stepped rents
d) other income

Answer 37

a) CPI increase