We are headed into that time of year
when landlords provide tenants
with their operating expense reconciliations. These are basically a “true-up” of
the actual costs incurred versus the costs
budgeted. When you receive this document,
it might be worthwhile to take a closer look
to discover if the charges are appropriate.
“In spite of best efforts, there are often mistakes on these documents,” says Matthew
Feeney, managing principal at CresaPartners.
“As a tenant, aside from wanting to make
sure that GAAP has been followed and that
the math has in fact been calculated accurately, it’s important to realize most landlords
issue their reconciliations based upon the
‘standard’ lease, and your lease may include
material differences from that ‘standard.’”
Smart Business asked Feeney what tenants should be looking out for when they are
presented with annual operating expenses.
What should tenants know about operating
expenses?
A well-negotiated lease document will
clearly define what are allowable operating
expenses, making explicit their proper
accounting treatment, and also define which
costs are not allowed to be charged to the
tenant. Typically, ‘operating costs’ include
your real estate taxes, cleaning, common
area maintenance, building insurance, management fees and repairs that had to be done
during the year. In practice, a landlord will
estimate the expenses of your property for
the upcoming calendar year. As a tenant you
will pay your percentage share of these estimates throughout the year. After the end of
the year when the actual expenditures can be
calculated (typically 90 to 120 days into the
year) the landlord sends a bill for any amount
that exceeded the budget. Over the course of
the lease, this can become a significant
expense that should, at the very least, be
understood. There is enough gray area in calculating operating expenses that entire businesses exist for the purpose of auditing operating costs on the behalf of clients.
When should tenants be concerned?
If you think the expenses are extraordinary,
you should ask your landlord for an explanation of the charges. Upon receipt of that
explanation, if there is still concern, you can
contact your real estate adviser or your
accounting firm. Often, the best way to go
about assuring accuracy is to contact a firm
that specializes in operating expense audits.
What you should look for is the percentage
of increase from your last year’s operating
expense statement. With the exception of
taxes, insurance and utilities, it’s customary
for most categories of operative expenses to
escalate between 3 and 5 percent per year. If
you move beyond this number you probably
want to question that and certainly if you hit
a double-digit number an explanation is due.
In particular, in our experiences, the following issues are often predicative of errors
or overcharges:
- Major work done to a building during the
year. If this is your situation you want to pay
very close attention to make sure that the
treatment of your operating expenses is done
according to generally accepted accounting
principles. For instance, if you have a new
roof put on your building, or if the lobby was
redone, those things should be capitalized
and, in the case of most leases, excluded
from the operating costs charged to tenants. - Changes in building ownership or management companies. New owners or property managers often implement their own
accounting practices and methedologies, and
these changes often create artificial increases
in the tenants’ obligations. - Vacancy in a building frequently leads to
errors and overcharges as a result of the landlord’s process of extrapolating the building’s
expenses to reflect what they would have
been at full occupancy (commonly referred
to as ‘gross up’).
What can be done to mitigate expenses?
Since you as a tenant do not control the
operation of the building you need to rely on
the professional expertise of the landlord.
The items that a tenant can control are typically limited to your HVAC and electric consumption. Keeping thermostats at a reasonable temperature and turning lights off or,
better yet, having light sensors installed can
help in this regard.
Another way to mitigate your expenses is
to have a well-negotiated lease document
and have the right to audit operating expenses. Without this right in your lease you have
limited recourse if expenses escalate rapidly.
Just the simple fact of having the right to
audit should help in making sure that expenses are properly accounted for. In some cases
we see companies performing annual audits
on the expenses as a matter of business practice. This certainly puts all parties on notice
that attention is being paid to this item and
tends to lead to a higher degree of accuracy
on the statements. Considering that 80 percent of reconciliation statements contain
billing errors, 25 percent of which are material enough to warrant an in-depth audit, tenants should pay very close attention to these
bills when they receive them.
When should a tenant forego an audit?
Simply stated, when there is no economic
benefit to doing so. A company should weigh
the potential return of conducting an audit
with the cost of having one performed to see
if there is a business case. Basically, tenants
under 10,000 square feet may not want to
bother with an audit as the return is likely to
be small.
MATTHEW FEENEY is a managing principal with CresaPartners. Reach him at [email protected] or (610) 825-3939.