Whether you are a tenant in an office, industrial or retail building, you are likely familiar with the commercial real estate CAM or operating expense charges passed on to you by your landlord. In a triple net lease, tenants are responsible for 100% of their proportionate share of these expenses on top of their rent. In a gross lease, tenants pay for their proportionate share that is in excess of the Base Year amount. These charges are above and beyond the base rent that is stipulated in the lease document and their unpredictability make them a sore spot for many businesses. Tenants receive these operating expense statements from their landlord’s property manager, but how can they know that they are accurately calculated?
At Hughes Marino, we audit hundreds of leases each year and have identified millions of dollars in erroneous charges. These savings would not have been achieved if not brought to our attention, so tenants need to be proactive in validating these charges or face the reality that they may be paying expenses that could be avoided.
Lease language pertaining to operating expenses is often heavily negotiated when signing a lease and vary from tenant to tenant based on their leverage during negotiations and the strength of their tenant representative broker. However, what the attorneys and brokers negotiate in the lease and to what extent they are conveyed to the property managers and accountants is where many errors can occur.
While the list is endless, here are five common issues that we see when reviewing our client’s operating expense statements.
Ignoring Operating Expense Caps
Negotiating caps on the operating expense increases in a lease is a big win, and not always easy to achieve. This protection limits the tenant’s exposure when the landlord is unable to keep increases within a reasonable range but is commonly overlooked by the managers and accountants that handle the day-to-day accounting at a property. Because caps are not standard to most tenants, the burden may be on the tenant to ensure property managers are aware of these caps and properly applying them.
Excessive Management Fees
Unlike most expenses, the management fee is a somewhat arbitrary figure agreed upon by the building owner and property manager, and in many cases, the owner acts as its own property manager. Like the above-mentioned cap on operating expenses, some leases limit management fees to 2 to 3% of the rent. This one is a little more difficult to spot because it often requires calculating the building’s approximate gross rent, however, it is important to check as a 1-2% change in the management fee can prove costly to tenants.
Inconsistently Applied Costs
It’s important that the management style of a building stay consistent from year-to-year. Adding certain expense categories such as security, earthquake insurance, or administration overhead can spike operating expense costs. This is especially common when a building is sold, and the new ownership applies their own management style. When a building sells, tenants should compare expenses presented by the new owner against prior year statements and question categories that appear to have incurred unreasonable increases.
Capital Passed Through or Not Amortized
Many leases have protections against landlord capital expenses. This means that the landlord cannot make improvements to the building that increase its value and pass those expenses on to tenants. These costs are sometimes hidden in other expense categories such as repairs and maintenance, so tenants must pay attention to this detail and challenge when necessary.
Base Year Issues
In a gross lease with a base year for expenses, that base year needs to be correct, as this will be a critical factor in future operating expense costs. Since this is the basis of future years’ expenses, the higher the amount the better. Landlords will sometimes underestimate this number or not use the proper base year amount in future years, and it can end up being costly in the long run.
The key to limiting bad operating expenses management by a landlord is an expertly negotiated lease. The reality is, if there are no operating expense protections in the lease, a landlord could pass on any and all expenses to their tenants.
If you feel your operating expenses may be incorrect or just want some peace of mind that you are being correctly billed, our lease audit experts on our Portfolio Lease Administration & Advisory team at Hughes Marino can provide a complimentary review. With a commitment to our clients that goes well beyond the signing of the lease, our experts can help you navigate through these charges to ensure you achieve significant savings.