Getting a Fair Break on The Pass-Throughs of Operating Expenses and Real Estate Taxes.
In the coming months, most commercial tenants will receive from their landlords reconciliations of prior year operating expenses, CAM expenses, taxes and insurance. With bottom lines under such universal attack, more and more corporations are revisiting lease audits as a tool to cut costs, since rent is the second largest business operating expense after employee compensation.
Landlords, by contrast, seem to have little problem passing along their rising costs to tenants. Sometimes, however, they abuse the privilege.
The following are examples reported in The New York Times of how successful, professional lease audits helped smaller businesses recoup illegitimate charges:
- A publishing company discovered it was charged $100,000 for the installation of a new cooling tower, a capital item that cannot be expensed to a tenant, and an extra $28,000 per year in cleaning costs based on an under-reported base-year cost. The company received credit toward its rent.
- A textile company subletting 12,000 square feet found that the primary tenant was allocating disproportionate share of its own escalations to the textile company,which recouped $175,000.
Not all situations have an immediate, satisfactory resolution. An outside audit revealed that Cincinnati-based Fifth Third Bancorp, was overcharged more than $800,000 in operating and maintenance expenses by Danis Properties Inc. The landlord disputed this finding and filed a lawsuit in May 2007.
The bank’s experience is a reminder that commercial tenants must pay greater attention to the impact of lease clauses on their rent bills, particularly during the initial or base year. Most companies have neither the time nor resources to scour rent bills for overcharges. A lease is a complicated document. It requires the scrutiny of industry experts, such as a professional lease auditor, who can catch seemingly minute mistakes that multiply over time into major losses.
These are examples of typical areas of dispute:
- Inclusion of certain expense and tax pass-throughs: Increased building operating costs are shifted or “passed through” to the tenant. Most leases do not allow the pass-through of tenant-procurement costs, financing and ownership costs, building depreciation, or capital improvements.
- Establishment of an underreported base year: The rent stated on the lease supposedly reflects the full costs of operating and managing the building at the beginning of the lease year, or the “base year.” In case of inflation, the lease will also include an operating expense escalation clause, which dictates that the tenant will pay the levels of cost increased over the base-year amount. The base-year rent might have been under-reported because of existing warranties and building vacancies. Landlords might also low-ball the base year to attract tenants.
Other common areas of dispute can include space issues and miscalculation of electricity fees. The landlord might discretely make a profit at your expense by purchasing electricity in bulk and reselling it at market price.
Having a professional, who represents tenants exclusively, negotiate the lease can shortstop many of these problems.
When is the best time for a lease audit?
Here are four instances
- A base-year audit is the most important. For a net lease, the base-year audit would be done for the first lease year, since the tenant is responsible for paying its pro-rata share of all expenses, starting on day one of the lease. This audit establishes the proper expense level against which all future years’ expenses will be measured. It also documents the landlord’s methodologies for calculating the base-year expenses, thus compelling the landlord to determine expenses on an “apples to apples” basis. For a gross lease, the audit should be performed the first year that the tenant is responsible for operating expenses or tax escalations.
- If building ownership changes hands, consider an audit. New owners look to improve their margins—often at the expense of the tenants.
- In the final year or two of its lease, an audit may provide not only financial reimbursement, but leverage for negotiating a lease extension.
- If the expenses rise beyond what appears reasonable, an audit may be appropriate. Review the year-to-year increases in specific expenses before doing an audit. If expenses rise sharply year-to-year due mostly to increased utility costs, an audit is probably not necessary.
Which tenants would benefit from performing a lease audit?
Zeve Associates, through its affiliation with two prominent national lease audit firms, P. Stevens Associates, and The Robert Thomas Group, offers an attractive solution. Each year, the lease audits performed by these companies, identify and recover millions of dollars for tenants that have overpaid — from Fortune 100 companies to smaller, privately-held firms. The larger the space, the greater the potential for overbilling. A tenant should have at least 10,000 square feet before considering an audit since there are normally minimum audit fees, although in some situations a base-year audit might be advisable.
Five Costly Mistakes in Lease Negotiations
- 1. Renewing a lease without representation and without establishing a true market rate for the space.
- 2. Beginning the search for new space without specific budget information or square footage requirements. Owners' agents and space planners act in the best interests of owners to maximize the utilization of available blocks of space.
- 3. Failure to recognize and analyze how workplace and space allocation trends might affect your company.
- 4. Neglecting to allot enough time to look for space or to relocate.
- 5. Believing, incorrectly, that you can save money by negotiating without professional representation.