The following FAQ’s are intended to provide clarification of some of the key concepts surrounding lease auditing. Additional in-depth information can be found in the Lease Tips section of this website.
Most leases require the tenant to bring errors to the landlord’s attention in order to receive rent adjustments. In fact, if the tenant does not do so, it is deemed to accept the bill as rendered and the landlord may keep any overcharges. Therefore, the timing of a lease audit can determine if a landlord is required to correct errors that are found.
To comply with these clauses, the tenant must follow a detailed notification procedure specified in the lease. This procedure includes time restrictions—the tenant often must give its notice within 30-90 days after receipt of the bill—as well as restrictions regarding the content of the notice. There are a number of common variations, many of which are detailed in our Lease Tip, “Audit Deadlines Come in All Forms.”
Be sure to check your leases for these limits, and pay particular attention to what you must do to comply with them.Click for printable page.
The simple answer is, in most cases, yes.
Many leases grant tenants the right to review the books and records of the landlord to ensure that the charges billed are correct. These clauses often state that the tenant has, upon reasonable notice, the right to visit the landlord’s offices and review the applicable accounting records. In addition, every tenant has a general contract right to ensure that the bills received are correct.
For a more detailed discussion of this issue, please see our Lease Tip, Negotiating Lease Audit RightsClick for printable page.
Errors in lease charges can range from simple miscalculations to wholesale misinterpretations of lease language. While most commercial leases share a common basic structure, leases are individually negotiated and almost always contain unique terms that will create errors if not meticulously followed.
Here is a sampling of things that often go wrong:
Operating Expenses / CAM Pass-Throughs
Pro rata share miscalculations ▪ Base year inadequacy ▪ Expense stop inadequacy ▪ Charging of excluded costs ▪ Improper charging of capital expenditures ▪ Incorrect calculation of savings for allowable cost-saving capital items ▪ Misallocation of costs among buildings ▪ Failure to bid service agreements ▪ Charging above-market fees for non-arms-length services ▪ Excessive management fees ▪ Failure to apply weighting to square footage ▪ Inclusion of costs directly reimbursed by tenants ▪ Inclusion of costs for unrelated buildings ▪ Inclusion of brokerage fees ▪ Inclusion of unpaid rents as bad debt expenses ▪ Misinterpretation of expense cap formulas ▪ Improper allocations of expense pools ▪ Improper inclusion of marketing fund charges ▪ Excessive administrative fees ▪ Improper calculation of association dues ▪ Improper inclusion of unrelated costs
Base Rent Charges
Per square foot rent miscalculations ▪ CPI miscalculations ▪ Rent commencement errors
Porters’ Wage Escalations (NYC)
Incorrect base years ▪ Incorrect selection of employee class ▪ Improper calculation of time-based benefits ▪ Erroneous inclusion of non-financial benefits ▪ Changing assumptions of benefit entitlement ▪ Failure to select statistical employee ▪ Incorrect use of multiplier ▪ Inclusion of incorrect insurance coverages ▪ Failure to discount for “new hires” ▪ Failure to discount for vacation replacements
Improper inclusion of vertical penetrations ▪ Use of incorrect BOMA or REBNY measurement standard for the building’s classification ▪ Improper inclusion of exterior building areas ▪ Measurement to incorrect interior surface ▪ Improper treatment of common areas ▪ Mismeasurement of rentable and common areas
Real Estate Taxes
Failure to apply tax refunds ▪ Failure to adjust tax base for incomplete assessments ▪ Failure to pursue tax certiorari consistently from year to year ▪ Improper inclusion of personal property taxes ▪ Improper inclusion of income taxes ▪ Failure to properly account for costs of tax professionals
Electric and Other Utility Charges
Misapplication of rates ▪ Use of incorrect rate schedules ▪ Addition of surcharges to utility costs ▪ Wiring of meters to unrelated spaces ▪ Misreading of meters ▪ Miscalculation of multipliers ▪ Incorrect assumptions as to usage ▪ Incorrect counting of equipment for surveys ▪ Failure to properly notify tenant of survey results ▪ Excessive charges for chilled water and condenser water ▪ Failure to recognize rate reductionsClick for printable page.
Although some landlords may prefer that their tenants not audit their leases, most landlords realize that tenants are required by corporate governance rules as well as by their internal audit departments to ensure that all lease charges are consistent with the contractual obligations (as established in the lease).
As lease audits have become more prevalent, most landlords today see them as a normal part of lease administration, especially given the fact that without conducting these reviews, there is no way for the tenant to verify its costs.
One of the best tests of how well an audit firm preserves its clients’ relationships with their landlords is the incidence of litigation over lease audit claims. A high incidence of litigation indicates that the firm is unable to persuade landlords of the validity of its claims, and the failure to effectively articulate positions.
For a more detailed discussion on how to maintain fairness in a lease audit, see KBA’s Lease Tip, “Fairness: The Goal of Lease Audits.”Click for printable page.
The most important skills to look for in a lease audit firm are:
The more the lease audit firm can offer in these four critical areas, the greater the benefit will be to your company.
For a more detailed discussion of this issue, please see KBA’s Lease Tip, “Criteria for Selecting a Lease Audit Firm”.Click for printable page.
Controlling real estate occupancy costs requires continuous diligence.
Although lease auditing can recapture overpayments your company may have unwittingly made, it doesn’t prevent overcharges from recurring, and it usually only addresses the larger locations. In order to prevent overcharges, a company must implement a regimen of constant monitoring of lease costs for all of its locations. It must also adopt a process by which it continuously improves its lease language for new transactions.
Constant monitoring of lease costs requires that each occupancy-related expense be verified and authorized by a qualified employee. In order to do this effectively, the employee must have ready access to the underlying legal documents, must check each and every expense against the documents and must have the ability to effectively question charges that appear incorrect. Although ready access to lease documents can be achieved through an effective lease administration system, in many companies these charges are authorized in the field by people who do not have access to such a system and therefore have no means to verify whether the amounts charged are truly due. Furthermore, if after checking a charge against the documents a question is raised, the person approving the bill must have know how to challenge it within the guidelines of the lease. If the person cannot effectively do this, then checking the charges against the documents becomes nothing more than an academic exercise.
In addition to checking bills against the legal documents, a good way to reduce costs in the long term is to constantly improve lease language. In many cases, a tenant may be charged for something that is clearly inequitable, but nothing can be done about it because the lease is inartfully drafted and the landlord is not legally required to withdraw its charge. Tenants should adopt a procedure to incorporate and re-write into its standard lease documents the lessons learned from its lease audit experiences (and from those of other companies).Click for printable page.
KBA’s lease audit process focuses on all of the rent and rent-related charges incurred by a tenant, and our analysis is geared to produce the greatest net recoveries for our clients while maintaining good business relations with their landlords.
Collection of Documents
KBA collects copies of all internal client documents needed for a preliminary analysis. This includes the lease, any subleases, all amendments, exhibits, estoppels and any pertinent correspondence between landlord and tenant. The relevant documentation also includes copies of all bills for escalations, including operating expenses, real estate taxes, utilities, porters’ wage and other similar charges.
The KBA audit process begins with a thorough review of all lease documents. We analyze all documents from the commencement of occupancy in order to gain an understanding of what the tenant agreed to and how the landlord-tenant relationship evolved. We then examine the bills received from the landlord and compare them to the obligations in the lease documents.
We perform tests for consi
stency with the lease language and conduct trend analyses of expense items incurred since lease commencement. For example, we analyze space size and utility consumption and compare the expense levels to the norms within each particular market. To make these comparisons, we refer to BOMA, other industry resources and our extensive database of lease information, developed from our many years of lease audit experience.
Resolution of Claims
In the event that KBA identifies charges that appear to be inconsistent with the lease documents, KBA will present its findings to the client. We consult with the client and determine how best to present our findings to the landlord. We then develop a resolution strategy in conjunction with the client. In executing our resolution strategy, we prepare all necessary correspondence and each letter is reviewed with our client prior to issuance (we will not contact a landlord without our client’s consent). Once a claim is resolved, we ensure compliance by the landlord upon resolution and when the recovery of savings is scheduled to occur after the date of resolution.
Correcting landlord billing errors requires specialized skills. To find errors, you must have accounting expertise as well as in-depth legal knowledge of lease clauses, of how your building operates and of how your landlord computes bills for its tenants. Unless you have a block of concentrated time and extensive resources, you will not be able to identify errors other than the most obvious ones.
In addition, to convince your landlord that the errors must be corrected, and do so without adversely affecting your relationship, you also need very effective communica
tion and negotiation skills. Unless you know how to communicate with your landlord’s accountants at their level, you will not be able to retrieve your overpayments.
Using a third-party lease audit firm significantly increases the amount of savings achieved and simultaneously reduces the potential for tension in this area.
For a more detailed discussion on what to look for in a lease audit firm, please see KBA’s Lease Tip, Criteria for Selecting a Lease Audit Firm.
Small errors in calculation of your base year can add up to significant costs every year of the lease.
KBA has been fantastic. They've helped us with everything from lease questions to audits and negotiations.