Prevent Overpayment of Your Company’s Leasehold Expenses
Real estate and leasehold expenses are among the most impactful upon your company’s bottom line. It is an essential element of any company’s fiscal management to ensure that it does not overpay. Auditing your landlord issued expenses is your right. Lease auditing has become a common and expected practice. Here are 6 indicators that suggest your business may benefit from conducting a lease audit.
1. Increases to the Building’s Operating Expenses
Perform a basic trend analysis of annual operating expense obligation if you notice a significant increase. Inflation and changing market conditions can contribute to increased operating expenses but if there is a significant jump issued to you, ask questions. A large increase may be due to an impermissible capital project, expense categories not reflected in your base year, vendor changes, or above standard services.
2. New Property Owner
A change in property ownership might trigger a lease audit.
Management fee levels, new vendors, and changing service levels are common issues when a building changes ownership or management. Another concern is the tenant estoppel which, if not carefully worded, has the potential to sign away rights or leverage.
3. Building Renovations or Upgrades
Renovations and capital projects may be subject to your lease operating expenses exclusions. Every project should be audited for permissibility under your lease. While you are most likely obligated to reimburse the landlord for a genuine building operating cost, you probably are not obligated to reimburse your landlord for increasing the value of his or her building if it does not reduce building operating costs in the future. If your building underwent renovations and/or capital improvements in the past, those costs were most likely amortized across future years. You may still be able to avoid ongoing expenses if they prove to be impermissible per your lease exclusions.
4. Your Lease is Commencing or Expiring
Perhaps the most valuable times to perform a lease audit are at the commencement and expiration of
your lease. If you occupy under a base year lease, the valuation of your base year will have a material impact
on your leasehold expenses throughout the remainder of the term. It is in your interest to validate all
charges and to validate expense levels in year one so as to not undervalue your base year. Likewise, lease
audits should always be performed as a standard practice at any lease expiration. Not only might you lose
rights to recoup any overcharges after vacating the premises, but you may lose significant leverages after
5. Dramatic Change in Building Occupancy Levels
Accounting for accurate building occupancy levels can have enormous implications for your operating
expense obligation. This can be magnified with regard to fixed versus variable expenses. If the vacancy
rate in your building is sizable, it benefits the fiscally conscious tenant to ensure that occupancy shifts are
accurately reflected within a given expense period.
6. Limited Support for Operating Expense Increase
A lease audit should automatically be triggered whenever an annual reconciliation is provided without sufficient back-up to verify expenses and calculations. Year-end reconciliations can carry significant financial impact. This is particularly true if your lease terms include caps or index-driven escalators. Any failure to timely challenge a landlord’s computations and/or inclusions may forfeit your rights thereafter. Accepting a rudimentary reconciliation is to trust your company’s finances to an outside party with a vested interest in maximizing its profits.
Ryan J. Hartsell , SIOR, MRE, Principal, and Managing Partner of Oxford Partners LLC, focuses on reducing the cost and risk associated with leasing and purchasing office and industrial property. He is recognized by his clients for his attentiveness, market knowledge, and negotiation prowess. He holds a master’s degree in commercial real estate and a bachelor’s degree in finance. As a third generation Houstonian and Principal of Oxford Partners, he has a unique appreciation for the business owners’ challenges by way of his own personal experience, which translates into better representation and empathy for his clients.