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Tips |
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Lease Auditing:
What Is It and How Does It Work? |
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Businesses are always seeking
ways to reduce expenses. Over the past 20 years, many
companies have utilized lease auditing as a low-risk,
high-yield way to reduce occupancy costs and improve their
overall financial control of their leases.
What is a Lease Audit?
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Most
leases contain operating expense “pass-through”
or "escalation" provisions
which allow the landlord to charge tenants
for the costs (or increases in costs) of cleaning, utilities, taxes,
insurance and other operating expenses.
A
lease audit is an examination of these
charges to determine if they are consistent with
the lease. It is a comparison of billed
amounts to lease provisions to ensure the tenant
is not overpaying its rental obligations. |
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Lease
Auditing is a valuable way for companies
to save money and improve control. |
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What
can go wrong with lease charges?
Landlords
have difficulty managing differing pass-through
clauses among multiple tenants in a building.
Operating
expense pass-through provisions are highly negotiated
and can vary widely from lease to lease. Many
landlords do not devote the resources necessary to
tailor each tenant’s bill to each unique lease.
Lease clauses
do not address unusual events that trigger increases
in operating costs.
As
a result, tenants are often charged for items
that they had no intention of paying for. For
example:
- One tenant may require a service that is not
needed by others (such as special cleaning or extra
air conditioning). Landlords often fail to exclude
such expenses from general building costs, and
other tenants may find themselves paying for them.
- Leases often allow the landlord to charge the
tenant for its electricity use. Landlords often
do not apply the correct rates or do not measure
each tenant’s usage properly.
- In leases with base years,
the first (aptly named the “Base”) year’s expenses often fail to accurately
reflect a full level of expenses. An understated
base year means that the pass-throughs are overstated
each and every year of the lease.
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What are the consequences of not auditing
your lease?
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Many leases provide that bills are
"deemed" correct if not contested within a defined
period of time (usually 30-60 days). Thus, not
checking the bills can mean permanent acceptance of an
incorrect charge.
However, the greater danger is that accepting
incorrect bills creates a precedent for how future bills
are determined. This can result in a tenant's
unwitting acceptance of an incorrect methodology,
further causing repetitive and cumulative overcharges
for the life of the lease. Even a relatively minor error can
become very expensive. |
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Tenants
that do not check their bills regularly
run the risk of embedding overcharges into
their leases for years to come. |
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Example:
Landlords have been known
to improperly charge tenants for the annual amortization
of major capital projects. In a 10-year lease,
the failure to object to an improper $20,000 amortization
charge the first time it appears may give the landlord
the right to include it for the remaining 9 years,
resulting in a tenant overcharge of its share of $200,000.
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Why is it difficult for companies to audit
their
own leases?
- Time: although most companies theoretically have
the resources available to audit rent bills, few can practically afford
to divert these resources from other projects.
- Expertise: auditing leases requires
specialized knowledge in commercial leasing, real estate
law, accounting, engineering and property management.
Claims Resolution
Once overcharges are identified, recovering them requires
significant additional time and expertise.
Tenant claims for overcharges must be presented
to the landlord in a clear, convincing, and
non-adversarial manner. In addition, the
tenant and its lease auditor must be able to
develop constructive ways to resolve claims
within the bounds of the existing business
relationship between landlord and tenant.
How is compensation typically structured?
Lease
auditing services are offered on hourly, fixed
fee or contingency bases.
- Hourly fee. Rates are similar to
law firms or accounting firms. Fees are due regardless
of the outcome.
- Fixed fee. Calculated at hourly fee
rates, this usually represents an estimate of the time
needed to complete various stages of the audit. As with
hourly fees, fixed fees are due regardless of the outcome.
- Contingency fee. This approach is
risk-free and is therefore the most favored. The only
fee to the audit firm is a percentage of rent reductions actually
received by the tenant. This ensures that the audit firm
focuses on material issues and does not pursue issues that are unlikely to
result in rent reductions for the tenant.
Conclusion
Over the past 20 years, lease auditing has become a recognized
part of the internal control procedures of many corporations,
and is a valuable way for companies
to control costs.
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