Definition
An expense pass-through is a lease provision requiring tenants to reimburse the landlord for their proportionate share of property operating expenses. These expenses commonly include property taxes, insurance, utilities, maintenance, and common area costs.
How It Works
- Landlord pays property operating expenses.
- Tenant reimburses their pro rata share.
- Reimbursements are often paid monthly with annual reconciliation.
Common Expense Categories
- Property taxes
- Insurance premiums
- Common Area Maintenance (CAM)
- Utilities (shared systems)
- Management fees
- Security and landscaping
Pro Rata Share Formula
Tenant’s Share = (Tenant Leased SF ÷ Total Rentable SF) × Total Expenses
Example
- Total Building Size: 50,000 SF
- Tenant Space: 5,000 SF
- Total Operating Expenses: $500,000
Tenant Share = (5,000 ÷ 50,000) × $500,000 = $50,000
Common Lease Structures Using Pass-Throughs
- Triple Net (NNN) Lease: Tenant pays most operating expenses directly.
- Modified Gross Lease: Tenant pays increases above a base year.
- Full-Service Gross Lease: Landlord pays most expenses, sometimes with base year stop.
Expense Pass-Through vs. Base Year
- Pass-Through: Tenant pays full pro rata share of expenses.
- Base Year: Tenant pays only increases above a benchmark year.
Impact on Financial Performance
- Protects landlord NOI from expense inflation.
- Shifts operational cost risk to tenants.
- Stabilizes underwriting assumptions.
Investor Perspective
- NNN leases reduce landlord expense volatility.
- Strong pass-through provisions improve asset predictability.
- Clear reimbursement language reduces disputes.
Tenant Perspective
- Lower base rent but variable total occupancy cost.
- Requires review of expense audit rights.
- Exposure to rising taxes and insurance costs.
Underwriting Considerations
- Review lease language for recoverable expense definitions.
- Analyze historical operating expense growth.
- Confirm gross-up provisions for variable expenses.
- Assess audit and reconciliation procedures.
Common Pitfalls
- Misclassifying capital expenditures as operating expenses.
- Failure to gross up partially vacant buildings.
- Ambiguous definitions of CAM.
- Improper allocation between tenants.