By Ed Muna
The term “audit” carries many negative connotations. From the burden of a corporate audit to the unknowns of a tax audit, everyone wants to steer clear of an “audit.” Because of this, many businesses avoid entertaining the process of a lease audit, and are potentially leaving millions of dollars on the table by allowing their landlords to charge them expenses that may not be permitted under their real estate lease.
Further, many companies assume that finding a mistake is like finding a needle in a haystack. What might surprise you is that history has shown approximately 1/3 of commercial tenants are paying more in operating expenses than required under their lease.
So before you write off what could be a very rewarding process, it is important that you know what a lease audit is, and what it is not.
It’s Not Really an Audit
While the real estate industry hasn’t been able to shed the word “audit” from “lease audit,” the process would be better described as a contract compliance review. Even Deloitte, one of the “Big Four” accounting firms, acknowledges in their literature that a lease audit should not be construed to be synonymous with the terms “audit” or any form of “attestation” service as described in the professional standards issued by the American Institute of Certified Public Accountants. As a matter of fact, Deloitte avoids the term “lease audit” whenever possible and simply calls the process lease consulting.
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Unfortunately, and by design, the audit language in most leases adds confusion for many tenants. The typical lease audit language looks the same as it did 30+ years ago when accounting was prepared on paper ledgers and landlords didn’t want disgruntled tenants fishing through their “books and records.” In order to keep tenants at bay, landlords offered costly and burdensome obstacles for them to partake in the process, including hiring one of the Big Four.
The good news for tenants is that the process of validating their operating expense charges does not require an audit right in the lease and should not trigger audit provisions that may exist. You will not need (or want) to hire a CPA, and the landlord’s books and records likely won’t come into play. Instead, the focus of today’s lease audits is on whether the inclusion of certain expenses is permitted under the lease and whether they comply with industry standards.
Each year I audit hundreds of leases and help clients identify millions of dollars in erroneous charges. On occasion a landlord will try to snuff the process by pointing to restrictive clauses in the lease, only to be brought back to earth with the assurance that I don’t need to look through their books and records. The bottom line is, if your real estate lease allows the landlord to pass through operating expenses, then you have the right to know if those charges are accurate.
Who Should Perform the Review?
So who should you turn to to validate your lease expenses? First off, do not hire an attorney or real estate agent who won’t have a strong understanding of the landlord’s management and accounting side of the equation, or a CPA who likely does not understand the legal or leasing side of the equation. I have lost track of the number of audits I have taken over from a single discipline professional only to find that they have barked up the wrong tree and wasted the time of both the tenant and the building owner.
While each of the above are masters of their craft, they typically do not possess all the skills needed for a successful review. The reality is an audit requires someone who understands landlord operating expense charges from multiple perspectives, from the broker who negotiates lease terms, to the attorney who crafts the language protecting your interests, to the property manager and accountants who determine what should be passed onto the tenant. Fortunately, there are a handful (but not a lot) of reputable lease audit firms who possess all of these perspectives in-house – Hughes Marino being one of them – which gives them the unique ability to help tenants identify and recover erroneous charges.
A good lease auditor will review your lease and operating expense statements at no charge and be able to provide advanced insight into your expense charges, showing you what is acceptable and what might be cause for concern. It is a risk-free proposition that every business owner should absolutely undertake, and one that will very likely have a positive impact on their bottom line.
Ed Muna is a senior vice president of Hughes Marino, an award-winning commercial real estate company specializing in tenant representation and building purchases with offices in San Diego, Orange County, Los Angeles, San Francisco, Silicon Valley and Seattle. Ed heads Hughes Marino’s Lease Administration and Audit Service divisions and helps tenants address issues that arise during their occupancy. Contact Ed at 1-844-NO-CONFLICT or firstname.lastname@example.org to learn more.