The typical lease contract is the end result of long hours of negotiation between landlord and tenant. Significant amounts of time and money are devoted by each side to achieve the most favorable set of terms and obligations. Over time, the lease document itself has increased in complexity as legal language has evolved to address a myriad of contingencies and conditions. ny corporation with multiple leases faces the challenging task of monitoring its actual obligations under its lease contracts. It is not surprising that some property managers employ several staff members whose primary job is to track the rent and expense obligations of their tenants. The rub lies in the diversity of lease language used for different properties. Many lease clauses fail to address the changes that can occur in occupied space, building measurements, escalation conditions, and pass-through allowances. This is where lease reviews can provide significant cost recovery potential for the tenant.
What is a Lease Review?
A lease review typically includes several phases. The first phase involves information research. The original lease, all lease amendments, sublease agreements, correspondence, floor plans, billing statements and reconciliations are requested from the landlord while payment records are provided by the tenant. From this information, a lease history is generated which details the occupancy and rent changes over the life of the lease.
Based upon the results of this research, the second phase reconstructs the tenant's payment history and confirms that payments made are in accordance with lease terms. Just as a Phase One Environmental Report recommends further study into the possibility of land contamination. the lease review process investigates rent collection histories, pass-through expenses. and occupied space records to reveal issues for potential recovery. As straightforward as this may seem, major discrepancies can occur between actual lease terms and how property managers interpret them.
The third phase in the process involves a thorough review of the landlord's or property manager's records to verify accounting procedures and to examine actual invoices. Expenses are examined to determine their appropriateness as tenant pass-through costs. Upon completion of this fieldwork, all potential recoveries are summarized as a documentation of findings for use in recovery negotiations.
The final phase in the lease review is the negotiation and recovery of overcharges. Supported by documentation, the tenant can present the findings to the landlord or property manager in an effort to recover all appropriate overcharges. The lease reviewer should be available to participate in these discussions as additional support.
Two additional opportunities for cost savings include vacant space cost recovery, which is achieved by identifying variable costs that have been paid for unrendered services, such as electrical, janitorial, and HVAC; and space measurement confirmation. which involves actually measuring the occupied space and comparing it with the space amount stated in the lease document. Space discrepancy directly affects the tenant's share of expenses.
The lease review process can go a step further by evaluating the building management practices. Benchmarking operation costs against industry averages shows how well property management is performing compared to its peers. Additionally, time trend analysis of previous years' operating costs provides insight regarding management efficiency efforts.
A comprehensive lease review also includes property management interviews to ascertain whether vendor bidding is conducted competitively and whether tax reassessments have been recently obtained to take advantage of the property value decline of the early 1990s.
Vendor services should also be questioned to determine if they are bid competitively. There have been cases where the property management employs internal service providers for which invoices may not be reliable. The tenant should be informed about such practice.
Utility management is another area that may not be as efficient as it could be. It is important to know how property management considers upgrades and what the plans are for the future.
Examples of cost recoveries include:
Rent Overcharge. Reconciliation of monthly billing statements with the lease history can yield discrepancies when occupied space expires on a certain month but rent charges do not reflect the change immediately, if at all. If the catch is not made, the monthly accrual of overcharged rent adds up quickly. Additionally, rent escalation clauses can often involve complex calculations which should be reviewed. While this is one of the property manager's most basic functions, it can be erroneously executed.
Inappropriate Pass-Through Expenses. A spot-check of several invoice records often reveals questionable pass-through expense practices. In one case, $90,000 in potential recoveries resulted from such inappropriate pass-through expenses as security golf carts, "chocolate" promotions, and exceedingly high administration office rent charges. The allocation method applied to each building should be routinely examined for accuracy.
Overcharges fop Occupied Space. Over time, lease amendments can change the occupied square footage, thus affecting the tenant's expense share. Lease amendments typically state changes in rent, space. and tenant share. However, these changes are not always accurately reflected in expense billings. In a recent lease review, a discrepancy of 2,800 square feet translated into an annual overcharge of $8,500 for one building. Similarly, building measurements can change over time when tenants move. Tenant share, as a percentage of total building area, therefore, can be directly affected depending on the language of the lease. In one such case, a single building's "growth" resulted in a potential recovery of $74,465 for one year.
Retroactive Recoveries. In many cases, space occupancy and building size issues have existed for several years. An extended investigation of billing statements would reveal the extent to which potential recovery is available. However, the statute of limitations must be considered for each case as well as the relationship between landlord and tenant. Before full recovery is sought. both parties may seek a compromise which will affect future lease negotiations.
The potential value of lease reviews to the tenant is significant. The issues discovered in the process may not only result in grounds for immediate recovery but may serve as a tool to gain more advantageous terms in future lease contracts.
The lease review process provides a deeper understanding of the tenant's corporate real estate management systems. As an objective party, the lease reviewer can help a tenant improve internal systems to capture updated, accurate information and reconcile its occupied space, rent, and expense share.
To be fair to landlords and managers, the vast majority of overcharges occur as a result of honest errors and misinterpretations in lease terms. Most landlords and managers welcome a second look and are as interested in the right answer as the tenant.
Errors in rents and expenses affect the value of a building upon sale and costly litigation can be avoided by thoroughly reviewing tenant leases.
In one case, the E&Y Kenneth Leventhal Real Estate Group was hired by a large owner to review 600 leases to assure that all tenant rents were being correctly charged.
A major concern for most companies is finding ways to reduce occupancy costs. One way to possibly put dollars back into your pocket is to take a close look at your leases, which typically are complex documents, and your operating expense statements, which can contain errors. To help clients identify potential savings or recover overpayments, Ernst & Young teamed with New A rica Network to develop a comprehensive lease review methodology called Lease Max[R].
Lease Max[R] is a service that targets office leases and focuses wholly on reducing occupancy-related costs, Lease Max[R] reviews the tenant's and property manager's documents to identify:
* errors in expense allocations
* payments made for unrendered, services
* errors in space measurement
Lease Max[R] also includes space planning and consolidation analysis, database creation for better lease administration and management, and tax assessment assistance.
This service is delivered by a multi-disciplinary team of professionals from the E&Y Kenneth Leventhal Real Estate Group and New America Network who have experience in lease audit, space measurement, asset management, property management, appraisal, investment, and real estate brokerage. Their skills and knowledge are utilized to pursue the many ways of achieving savings for clients.
For more information on Lease Max[R], contact John Tierney, E & Y Kenneth Leventhal Real Estate Group, Philadelphia, PA, (215) 448-5038.
Haig J. Assadourian is a member of the E&Y Kenneth Leventhal Real Estate Group, Los Angeles, CA, (213) 977-3942.