Businesses are always seeking ways to reduce expenses. Over the past 30 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?
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.
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.
What are the consequences of not auditing your lease?
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.
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.
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.
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.
Over the past 30 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.