Strategies for Drafting Caps on Controllable Expenses in Commercial Leases

04.2026

As practitioners of commercial leasing, representing both landlords and tenants, we have found that issues surrounding capping controllable operating expenses are often misunderstood. The primary methods for increasing the cap on controllable expenses in commercial leases, listed both in order of regularity (in our experience) and increasing favorability to landlords (and thus decreasing favorability to tenants), are: 

1. Compounding on prior year expenses;
2. Straight line increase; and
3. Compounding on the cap.

Additional mechanisms available to landlords to mitigate the effect of the cap are available but do require specific drafting to have definitive legal effect.  Parties may also compromise by mixing and matching escalation methods and mitigation mechanisms.  These include:

• Recapturing above-cap expenses from prior years in subsequent below-cap years, effectively reducing the cap in those latter years (demonstrated in purple text in tables below). This is very common in our experience.
• Carrying forward excess or unused cap (demonstrated in blue text in tables below). This is best addressed explicitly, but also seems to be what drafters intend by including the word “cumulative” as it relates to cap increases (although the legal effect of that word to yield that result is questionable, as explained below in Legal Analysis).
• Grossing up to achieve trailing average equal to the cap percentage (not demonstrated in tables below). We find this to be less frequently used.
• Reset the base year at certain intervals to ratchet up the base expense (not demonstrated in tables below). We find this to be less frequently used.

Drafters should be specific about what they intend.  Merely saying “cumulative” or “compounding” might not give a landlord exactly what it wants, and a tenant does not necessarily need to get hung up on “non-cumulative” or “non-compounding”.  To achieve the desired effect, drafters should specify whether the cap increases each year over the prior year expenses payable or the prior year cap itself, and also specify which, if any, additional mitigation mechanisms they intend.

Legal Analysis and Examples:

We have found no case law specifically interpreting caps on controllable expenses, but we can draw guidance from how courts interpret other rental increases.

Massachusetts, 2009: The lease provided for rent to be increased annually, “on a cumulative basis, by 3%”.  Tenant argued that language meant a 3% increase each year over the initial year (i.e., no compounding).  However, the court read “cumulative” to be synonymous with “compounding” and thus agreed with landlord that rent increases by 3% year-over-year.  Rogers Street, LLC v. MBA-Rogers St. LLC, 2009 Mass. Super. LEXIS 268. 

It appears the word “cumulative” was critical in the court’s decision, and the absence of that word could have swayed the court in favor of tenant.  In other words, it’s more critical for landlord to specify “cumulative” or “compounding” than it is for tenant to specify “non-compounding” or “non-cumulative”.

Massachusetts, 1979:  The lease provided for tenant to pay increases in taxes over a certain base year, “but in no event to exceed $4,320 annually.”  The court found the provision to be “noncumulative,” such that tenant’s liability each year was capped at $4,320, with no change in the cap year to year.  John J. Duane Realty Corp. v. Great Atlantic & Pacific Tea Co., 8 Mass. App. Ct. 899.  The landlord may have obtained its desired result had it used the word “cumulative.”

These cases indicate courts will interpret “cumulative” to be synonymous with “compounding” and provide no support that such word alone yields a right to recapture or carry-forward. 

Based on these cases, the following capping provisions would likely be interpreted as follows:

• “Controllable Operating Expenses shall not increase by more than 5% per year on a compounding [cumulative] basis” – The cap increases each year relative to the prior year’s controllable operating expenses (as capped), rather than on the cap itself since the cap is not actually mentioned. The language itself confers no right to carry-forward or recapture.
• “Controllable Operating Expenses shall not increase by more than 5% per year on a non-compounding [non-cumulative] basis” – The cap would increase at a fixed amount each year equal to 5% of the base year’s controllable operating expenses. There is certainly no right to carry-forward or recapture.
• “Controllable Operating Expenses shall not increase by more than 5% per year” – This would likely be interpreted as non-cumulative (non-compounding), but there would be room for argument. There is no indication of any right to carry forward or recapture.

Please see below for examples to demonstrate the real-world effect of the different computation methods and mitigation strategies.

Compounding on Prior Year Expenses

Description: The cap increases each year relative to the prior year’s expenses (as capped in that prior year).

Sample Language: “The annual increase in Controllable Expenses is limited to 5% of the prior year’s Controllable Expenses”  OR “Controllable Operating Expenses shall not increase by more than 5% per year on a compounding [cumulative] basis” (additional language would be needed to support the carry-forward and recapture rights).

Example:

Year	Cap	Actual	Shortfall	Carry-Forward	Recapture
Base	N/A	$100,000	-	-	N/A (base year)
2	$105,000 (+5% YoY)	$104,000 (+4% YoY)	-	-	N/A (no shortfall yet accrued)
	-	-	-	$1,000 (carry to Y3)	-
3	$109,200 (+5% YoY)	$111,280 (+7% YoY)	($2,080)	-	N/A (Actual > Cap)
	$110,200 (+5.96% YoY)	same	($1,080)	N/A (Actual > Cap)	N/A (Actual > Cap)
4	$114,660 (+5% YoY)	$116,844 (+5% YoY)	($2,184)	-	N/A (Actual > Cap)
	$115,710 (+5% YoY)	same	($1,134)	N/A (Actual > Cap)	N/A (Actual > Cap)
5	$120,393 (+5% YoY)	$121,518 (+4% YoY)	($1,125)	-	N/A (Actual > Cap)
	$121,496 (+5% YoY)	same	($22)	N/A (Actual > Cap)	N/A (Actual > Cap)
Totals	+20.393% cum.	+21.52% cum.	($5,389)	-	N/A
	+21.49% cum.	same	($2,236)	$1,000	N/A

Deal Dynamics:  Simple in that it follows the same escalation method as base rent, but unpredictable and more difficult to track over the years as each year’s cap is based on the prior year’s expenses.  Favors tenant because the entire trajectory is lower if actual expenses are less than the cap.  Places pressure on landlord to prevent actual expenses from falling below the cap.

Straight Line Increase

Description: The cap increases each year relative to the base year, regardless of actual expenses.

Sample Language: “The increase in Controllable Expenses each year is limited to 5% over the Base Year Controllable Expenses”  OR “Controllable Operating Expenses shall not increase by more than 5% per year on a non-compounding [non-cumulative] basis” (additional language would be needed to support the carry-forward and recapture rights).

Example:

Year	Cap	Actual	Shortfall	Carry	Recapture
Base	-	$100,000	-	-	N/A (base year)
2	$105,000 (+5% YoB)	$104,000 (+4% YoY)	-	-	N/A (no shortfall yet accrued)
	-	-	-	$1,000 (carry to Y3)	-
3	$110,000 (+10% YoB)	$111,280 (+7% YoY)	($1,280)	-	N/A (Actual > Cap)
	$111,000 (+11% YoB)	Same	($280)	N/A (Actual > Cap)	N/A (Actual > Cap)
4	$115,000 (+15% YoB)	$116,844 (+5% YoY)	($1,844)	-	N/A (Actual > Cap)
	$116,500 (+16.5% YoB)	Same	($344)	N/A (Actual > Cap)	N/A (Actual > Cap)
5	$120,000 (+20% YoB)	$121,518 (+4% YoY)	($1,518)	-	N/A (Actual > Cap)
	$122,325 (+22.33% YoB)	Same	None	$183 after recapture (carry to next year)	$624 (apply this year)
Totals	+20% cum.	+21.52% cum.	($4,642)	-	$0
	22.33% cum.		($624)	$1,183	$624

Shortfall net of Recapture = $0

Deal Dynamic: Simple.  Predictable.  Easy to track over the years since prior expenses are not relevant.  Favors landlord because the cap is constantly increasing at a fixed rate regardless of actual expenses.  Relieves landlord of pressure to keep expenses above the cap.

Compounding on the Cap

Description: The cap increases each year relative to the prior year’s cap, regardless of expenses.

Sample Language: “The annual increase in Controllable Expenses is limited to 5% of the prior year’s cap on a compounding [cumulative] basis” (additional language would be needed to support the carry-forward and recapture rights).

Example:

Year	Cap	Actual	Shortfall	Carry	Recapture
Base	N/A	$100,000	N/A	-	N/A (base year)
2	$105K (+5% YoY)	$104,000 (+4% YoY)	None	-	N/A (no shortfall yet accrued)
	-	-	-	$1,000 (carry to Y3)	-
3	$110,250 (+5% YoY)	$111,280 (+7% YoY)	($1,030)	-	N/A (Actual > Cap)
	$111,250 (+5.95% YoY)	same	($30)	N/A (Actual > Cap)	N/A (Actual > Cap)
4	$115,763 (+5% YoY)	$116,844 (+5% YoY)	($1,081)	-	N/A (Actual > Cap)
	$116,813 (+5% YoY)	same	($31)	N/A (Actual > Cap)	N/A (Actual > Cap)
5	$121,551 (+5% YoY)	$121,518 (+4% YoY)	None	-	$33 (apply this year)
	$122,654 (+5% YoY)	same	None	$1,075 after recapture (carry to next year)	$61 (apply this year)
Totals	+21.55% cum.	+21.52% cum.	($2,111)	-	$33
	+22.66% cum.	same	($61)	$2,075	$61

Shortfall net of Recapture = ($2,078)

Shortfall net of Recapture = $0

Deal Dynamics:  Predictable and easy to track annual increases, regardless of actual expenses.  Most favorable to landlord because the cap constantly increases (with compounding) even if actual expenses fall one year.  Relieves landlord of pressure to keep expenses above the cap.

Conclusion

Leasing parties and their counsel should be careful that the language in their leases related to caps on controllable expenses clearly reflect their intent.  A failure to do could inadvertently yield results that do not align with their expectations.

Andrew Hirsch is a partner in the Tysons, Va office of Hirschler.  He is a trusted advisor to real estate investors, developers and other entities as it relates to real estate and corporate matters. He may be reached at ahirsch@hirschlerlaw.com.