A lease that requires the tenant to pay a share of expenses above a base-year amount contains:
Correct Answer
D) An expense stop
Why this is correct: An expense stop is a lease clause that caps the landlord's responsibility for operating expenses at a base-year amount. Expenses exceeding that base amount are passed through to the tenant. This structure directly matches the question's description of a tenant paying a share of expenses above a base-year amount. Why the other choices are wrong: A right of first refusal gives a tenant the opportunity to match an offer before a property is sold to a third party, unrelated to expense sharing. A percentage rent clause requires a retail tenant to pay additional rent based on a percentage of their sales volume, not operating expenses. A ground lease provision pertains to leasing land, typically for a long term, and does not define the specific expense-sharing mechanism described. Exam tip: For expense-related clauses, 'stop' means the landlord's responsibility stops at a defined level (base year, dollar amount), with excess passed to the tenant.
Why This Is the Correct Answer
An expense stop is precisely the mechanism described: the landlord's obligation stops at a defined base, and the tenant pays a proportionate share of the excess. The base is usually the actual expenses of a stated base year, though it can also be a fixed dollar amount per square foot. Recognizing the clause tells the appraiser to model reimbursement income and to check whether the base year is stale, since an old base shifts more cost to the tenant and affects what the space can command in market rent terms.
Why the Other Options Are Wrong
Option A: A right of first refusal
A right of first refusal lets the holder match a bona fide third party offer, usually to purchase the property or to lease adjoining space. It affects marketability and the pool of likely buyers, and it may need to be analyzed as an agreement affecting the subject, but it says nothing about who pays operating costs. The option tests whether you can tell a purchase right from an expense mechanism.
Option B: A percentage rent clause
Percentage rent is overage rent computed on a tenant's gross sales above a stated breakpoint, and it is a feature of retail leases tied to sales volume rather than to costs. It raises income when the tenant does well; an expense stop raises income when costs rise. Both add to collections beyond base rent, which is what makes the confusion possible.
Option C: A ground lease provision
A ground lease conveys the right to use land, usually for a long term with the tenant constructing and owning improvements, and it creates the leased fee and leasehold interests the appraiser must identify. It is a description of what is leased, not of how operating expenses are allocated. Ground leases can contain expense provisions, but the term itself does not name one.
The Stop Is Where the Wallet Closes
Picture the landlord's wallet snapping shut at the base year figure. Everything above that line gets slid across the table to the tenant. Stop means stop paying, not stop increasing.
How to use: When a stem mentions a base year, a base amount, or expenses above a level, name the expense stop and then remember to put the pass-through into effective gross income. If the stem mentions sales volume instead of costs, it is percentage rent.
Exam Tip
Sort income clauses by the trigger. Costs above a base means expense stop, sales above a breakpoint means percentage rent, and neither one is a description of what is being leased.
Common Mistakes to Avoid
- -Omitting expense recovery income from effective gross income
- -Deducting operating expenses the tenant actually reimburses without recording the reimbursement
- -Treating a modified gross lease with a stop as though it were full service
Concept Deep Dive
Analysis
Commercial leases divide operating expenses between landlord and tenant, and the appraiser has to read that division correctly before the reconstructed operating statement can be built. An expense stop fixes the level of operating expenses the landlord will absorb, commonly the amount incurred in the base year, and passes each tenant a pro rata share of everything above that level in later years. The effect is to shift inflation risk in taxes, insurance, utilities, and common area maintenance from the landlord to the tenant while leaving the base amount with the landlord, which puts the lease somewhere between full service and net in economic substance. For valuation, the pass-through amounts appear as recovery or reimbursement income in effective gross income and the full expenses appear on the expense side, and misreading the clause causes both lines to be wrong at once.
Background Knowledge
You need the lease structures encountered in the income approach, including gross, modified gross, net, triple net, and ground leases, and the vocabulary of pass-throughs, common area maintenance, and expense stops. You also need to know how reimbursement income is treated in the reconstructed operating statement and why matching the expense treatment to the lease terms is necessary to avoid double counting or omission.
Real-World Application
An appraiser analyzing a suburban office building finds leases with 2019 base year stops, computes each tenant's share of the increase in taxes and insurance, adds the recoveries to effective gross income, and notes that tenants renewing today will reset to a current base year, which lowers projected recoveries.
More Income Approach Questions
In a percentage lease, rent is commonly structured as:
In a DCF, what is the reversion?
Potential gross income differs from effective gross income in that PGI assumes:
The reversion in a discounted cash flow model represents:
Building A (new, credit tenant, 20-year lease) and Building B (older, month-to-month tenants) sell the same week. Their cap rates should differ how?
An overall rate extracted from a sale whose NOI excluded reserves, applied to a subject NOI that includes them, will:
Replacement reserves cover which kind of expenditure?
What is the primary distinction, for appraisal purposes, between 'vacancy loss' and 'collection loss'?
An appraiser is analyzing a mixed-use property with retail and office components. The retail segment has a potential gross income of $180,000 with a market vacancy of 8%. The office segment has a potential gross income of $120,000 with a market vacancy of 12%. What is the overall effective gross income for the property?
The mortgage constant represents:
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A 20-unit apartment building is fully occupied with rents at $1,500 per month per unit. Market data indicates a 6% vacancy and collection loss is typical. Management also anticipates 1.5% of effective gross income will be lost to credit loss from tenant non-payment and lease skips. What is the stabilized estimate of effective gross income for the property?