Gross Reimbursement Structure

Definition of Gross Reimbursement Structure

In the context of commercial real estate and mortgages, a Gross Reimbursement Structure (often associated with a Full Service Gross Lease or a Modified Gross Lease) refers to a financial arrangement where the landlord is initially responsible for paying all of the property's operating expenses. These expenses typically include real estate taxes, property insurance, and common area maintenance (CAM). However, the "reimbursement" aspect triggers when these expenses exceed a predetermined threshold, known as a base year or expense stop, at which point the tenant must reimburse the landlord for the excess amount.

Detailed Description and Mechanics

The Gross Reimbursement Structure is a hybrid model designed to provide initial cost certainty for the tenant while protecting the landlord—and by extension, the mortgage lender—from inflationary increases in operating costs. Below are the core components of this structure:

• The Base Year: This is usually the first calendar year of a lease. The operating expenses incurred during this year set the "floor." The landlord pays 100% of these costs, and they are factored into the initial base rent.
• Expense Stops: In some commercial mortgages and leases, a specific dollar amount per square foot is set as the limit the landlord will pay. Any costs incurred above this expense stop are passed directly to the tenant as a reimbursement.
• Reimbursable Expenses: These generally include "variable" costs such as utilities, janitorial services, landscaping, and security, as well as "fixed" costs like property taxes and premiums for building insurance.
• Pro-Rata Share: If a building has multiple tenants, each tenant is responsible for their pro-rata share of the increases based on the percentage of the total building square footage they occupy.

Importance in Commercial Mortgage Underwriting

Lenders scrutinize Gross Reimbursement Structures during the loan underwriting process because they directly impact the Net Operating Income (NOI) and the Debt Service Coverage Ratio (DSCR). Here is how this structure affects the mortgage perspective:

• Inflation Protection: For a lender, a "pure" gross lease (where the landlord pays everything regardless of price hikes) is risky. A Gross Reimbursement Structure mitigates this risk by ensuring that the property's bottom line is not eroded by rising taxes or utility costs.
• Predictability of Cash Flow: Because the tenant covers the "overage," the landlord’s net income remains relatively stable even if the building's operating costs fluctuate. Lenders prefer this stability as it ensures the borrower has sufficient funds to make mortgage payments.
• Valuation Impacts: When appraising a property for a mortgage, the ability to recapture expenses through a reimbursement structure can lead to a higher property valuation, as it lowers the risk profile of the investment.
• Lease Rollover Risk: Lenders will examine the base years of various tenants. If many tenants have very old base years, the landlord may be absorbing a significant amount of cost before the reimbursement kicks in, which can be a red flag during the financing process.

Ultimately, a Gross Reimbursement Structure serves as a middle ground in commercial financing, offering the tenant a simplified monthly payment while providing the landlord and lender a "safety valve" against the rising costs of property ownership.