Two caps with the same 5 per cent can bill a tenant very different amounts. The difference is set by the path of costs, and it can be computed year by year.
A cumulative cap lets unused increases carry forward; a non-cumulative cap loses them every year. On the worked anchor tenancy, with 5 per cent caps on controllable costs over ten years, the tenant pays 494,156 under a compounded cumulative cap and 460,806 under an annual non-cumulative cap: a difference of 33,350, or 6.7 per cent of the recovery. The gap depends on the path of costs, not on the drafting alone.
Worked in full in How to Read a Commercial Lease by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
How to Read a Commercial Lease says a 5 per cent cumulative compounded cap and a 5 per cent annual non-cumulative cap "can differ by twenty percent or more of the recovery over ten years", and that a cap must be built as a running schedule. Its companion files build that schedule on the book's own anchor: a base-year pool of 983,500 grossed up to 95 per cent occupancy (9.84 a foot on 100,000 sf), of which the tenant pays a 25 per cent share of any increase over the base year. The split between controllable and uncontrollable costs and the cost path are added, illustrative inputs.
| Input | Value |
|---|---|
| Base-year pool | 983,500 |
| Controllable share (the cap reaches only this part) | 60% = 590,100 |
| Uncontrollable: taxes, insurance, utilities | 393,400, +4% a year |
| Tenant share of increases over base year | 25% |
| Cap on controllable costs | 5% |
| Controllable growth, years 2 to 10 | 1, 1.5, 9, 8, 2, 1, 7, 6, 2% |
Non-cumulative (annual): ceilingn = chargedn−1 × 1.05. Unused headroom is lost.
Cumulative, simple: ceilingn = base × (1 + 5% × n)
Cumulative, compounded: ceilingn = base × 1.05n
Tenant pays = 25% × (MIN(actual controllable, ceiling) + uncontrollable − base-year pool)
Excel, non-cumulative: =MIN(Actual_n, Charged_n-1*(1+Cap))
In years 2 and 3 controllable costs rise 1 and 1.5 per cent and no cap binds. In year 4 they jump 9 per cent to 659,386. The non-cumulative ceiling is last year's 604,941 times 1.05, or 635,188, so 24,198 of controllable cost is excluded and the tenant pays 6,049 less. The compounded ceiling for year 4 is 683,115: the two quiet years left headroom, and it absorbs the jump. In year 5 costs rise another 8 per cent to 712,137, still under the compounded ceiling of 717,270, while the non-cumulative ceiling binds again.
| Year | No cap | Non-cumulative | Cumulative, simple | Compounded |
|---|---|---|---|---|
| 2 | 5,409 | 5,409 | 5,409 | 5,409 |
| 3 | 11,736 | 11,736 | 11,736 | 11,736 |
| 4 | 29,602 | 23,552 | 29,602 | 29,602 |
| 5 | 47,215 | 35,917 | 46,211 | 47,215 |
| 6 | 55,378 | 48,857 | 55,378 | 55,378 |
| 7 | 61,980 | 61,980 | 61,980 | 61,980 |
| 8 | 79,796 | 76,128 | 79,796 | 79,796 |
| 9 | 96,748 | 90,934 | 95,259 | 96,748 |
| 10 | 106,293 | 106,293 | 106,293 | 106,293 |
| Total | 494,156 | 460,806 | 491,663 | 494,156 |
On this path the compounded cap never binds: the tenant pays exactly what it would with no cap at all. The non-cumulative cap binds in every hard year and takes 33,350 off the landlord's recovery over the term, 6.7 per cent. The simple cumulative cap sits close to the compounded one, binding only in years 5 and 9. Note also that the non-cumulative cap catches up in years 7 and 10: when costs rise slowly, the ceiling grows faster than costs and the lost ground is partly recovered.
The size of the gap is a property of the cost path. Take four quiet years at 1 per cent, a single jump in year 6 (a new security contract, a cleaning retender), then 2 per cent a year.
| Jump | Compounded | Non-cumulative | Gap | Gap, share of recovery |
|---|---|---|---|---|
| 5.0% | 313,420 | 313,420 | 0 | 0.0% |
| 10.0% | 353,365 | 342,696 | 10,669 | 3.0% |
| 15.0% | 393,310 | 360,424 | 32,886 | 8.4% |
| 23.0% | 456,572 | 365,258 | 91,314 | 20.0% |
| 30.0% | 495,945 | 365,258 | 130,688 | 26.4% |
The book's "twenty percent or more" holds, but only once a single year's jump reaches 23.0 per cent after a run of quiet years. Steady inflation produces a small gap; one large step after a calm period produces a large one, because that is exactly when a cumulative cap has headroom banked and a non-cumulative cap has none.
The lazy model grows the whole pool at the cap rate. Here that gives the tenant 633,839 over ten years, 139,683 or 28 per cent more than the compounded schedule, because it applies the 5 per cent to uncontrollable costs that rise at 4 per cent and are not capped at all. The error can run the other way when taxes or insurance rise faster than the cap, so the only safe model splits the pool into what the cap reaches and what it does not, and builds each ceiling year by year.
For a landlord, a non-cumulative cap is worth negotiating away before a year in which a known cost reset is coming. For a tenant, it is worth most in a building whose costs move in steps rather than smoothly.
The schedule, the jump that produces twenty per cent and the split of the pool are live in the case workbook on the free workbook page for this book. For the same discipline applied to a rent roll's upside, see what a lease mark-to-market is actually worth.
A cap that limits each year's controllable expense charge to a percentage over the previous year's charge, with any unused allowance lost. In the worked case a 9 per cent cost rise in year 4 is cut to 5 per cent over the prior year, excluding 24,198 of cost and 6,049 of the tenant's share.
A simple cumulative cap lets the ceiling rise by the cap percentage of the base each year; a compounded cap multiplies the base by 1.05 to the power of the years. Over ten years the worked tenant pays 491,663 under the simple version and 494,156 under the compounded one.
It applies the cap to costs it does not reach and ignores the path. Growing the whole 983,500 pool at 5 per cent bills the tenant 633,839 over ten years, 28 per cent more than the true schedule, because taxes and insurance rising at 4 per cent are not capped at all.
The caps are compared in chapter 8 of How to Read a Commercial Lease; the schedule is built in the book's free case workbook. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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