Base Month

Definition of Base Month

In the context of commercial real estate and commercial mortgages, the Base Month refers to a specific calendar month used as a reference point to establish the baseline for operating expenses and taxes. It is the period during which the landlord is responsible for all costs associated with the property’s operation. Any increase in these costs in subsequent months or years is typically passed through to the tenant as an expense escalation.

Detailed Description and Application

The concept of a Base Month is most frequently found in Gross Leases or Modified Gross Leases. When a lender evaluates a commercial mortgage application, they scrutinize these terms to determine the stability of the property’s Net Operating Income (NOI). Here is a detailed breakdown of how the Base Month functions:

• The Expense Stop: The Base Month essentially creates an "expense stop." If the total operating expenses (such as utilities, insurance, or maintenance) for the Base Month are $5,000, the landlord is committed to paying up to that amount for the duration of the lease. If expenses rise to $5,500 in a future period, the tenant is responsible for the $500 difference.
• Negotiation Point: The selection of the Base Month is a critical negotiation point. Landlords prefer a month with historically low expenses to ensure more costs are passed to the tenant, while tenants prefer a Base Month with higher expenses to minimize their future liability.
• Impact on Underwriting: For a commercial mortgage lender, the Base Month provides a "floor" for the property's expenses. Lenders prefer leases with clearly defined Base Months because they protect the property’s cash flow from being eroded by inflation or rising utility costs, thereby ensuring the borrower can maintain their Debt Service Coverage Ratio (DSCR).
• Timing: The Base Month is usually the first full month of the lease term or the month in which the tenant first takes possession of the space.

Importance in Commercial Mortgages

Lenders view the Base Month as a risk-mitigation tool. In a commercial mortgage, the collateral is the income-producing potential of the property. If a lease does not have a Base Month or a similar Base Year provision, the landlord (the borrower) would be forced to absorb all increases in operating costs. This could lead to a decrease in profit margins and increase the risk of default if expenses spike. By verifying the Base Month provisions in the rent roll and lease abstracts, a lender can more accurately forecast the Long-Term Value (LTV) and the safety of the loan.

In summary, the Base Month acts as a financial benchmark that stabilizes the landlord's expenses, providing a predictable income stream that is essential for securing favorable terms on a commercial mortgage.