In most cases, when you’re a property owner of Alaska commercial real estate, you will be responsible for the operating expenses for the building that will run the gamut from insurance, to necessary repairs and maintenance, to utilities (like electricity and water), and taxes. In order to recover some of these costs, the property owner can choose to bill back these direct operating expenses to the tenant(s). This is often referred to as Additional Rent, or a Direct Operating Expense Pass-Through.

Direct Operating Expense Pass Through Increases

In this lease clause between tenant and landlord, the tenant agrees to pay as additional rental an amount equal to their proportionate share of any increase in the amount of “direct operating expenses” as defined in the lease, over the total “direct operating expenses” payable by Landlord during the “base year” of the lease (which is usually the first year of occupancy).

How much is billed back, or passed through to the tenant?

This direct operating expense pass through is based on the increase from the base year and the pro rata share.

What is the base year?

As mentioned above, the base year is typically set the first year of occupancy. The price a tenant is quoted, for example $20 per square foot, includes a percentage of the operating expenses. The landlord will reconcile their books at the end of every year and determine what the operating expenses are per square foot. If after the landlord reconciles their books and finds the expenses were actually $10 per square foot, that will become your base year. Every year afterward, any expenses over $10 per square foot will be billed to the tenant separately and if they are $10/sf or under, the tenant pays nothing.

What exactly are the direct operating expenses?

Direct operating expenses can mean the total of any and all of the following expenses paid by or incurred by the landlord in the operation of the property— including:

– Utilities, including electricity, gas, water/sewer and refuse pickup
– Services, including common area janitorial, window washing, lot sweeping, snow removal, security, management and leasing
– Maintenance and repairs
– Insurance, including but not limited to fire, extended coverage, other insurable hazards or casualties, public liability and loss of rents
– Taxes, including the total amount of taxes now or hereafter levied, assessed or imposed against the real property
– All other out of pocket expenses incurred by Landlord in reasonably operating the real property for the common benefit of all tenants, except for debt service.
Direct operating expense pass-throughs are just one of many topics you’ll need to consider when investing in Alaska commercial real estate and we’re here to help guide you every step of the way. Give Northern Edge Real Estate a call today for more information about available properties in the Anchorage area or for tips on finding the best deal, identifying risk, and tax benefits!