In today's business environment, many corporations spend a lot of time trying to reduce small expenses such as pencils and USB sticks. However, they often fail to examine one major expense: The cost of real estate.
Many entrepreneurs are not familiar with commercial real estate leases and they lack the resources and expertise to review charges billed to them in accordance with their lease. Leases are complex documents drafted by lawyers, and there are several gray areas left open to interpretation.
Internal audits provide an independent analysis of a tenant's occupancy costs to ensure that additional charges are charged the way they should be. According to a Deloitte 2010 Lease Administration Benchmarking Survey, lease audits and reviews can result in cost reductions or expense recoveries ranging from 50 cents to $2 per square foot.
Review your lease. Most commercial leases originate from the landlord's standard form. Then, the lease is negotiated between the parties and modifications are brought to reflect the result of the negotiations.
A commercial lease should clearly identify the rentable area of the premises. It is also important to have the premises measured by an architect upon commencement of the term. There are many cases where tenants were occupying less space than what is indicated in the lease. This leads to inaccurate invoicing.
The lease also indicates the amount the tenant must contribute towards "common-area maintenance" expenses, commonly referred to as "CAM." The method used to determine the tenant's proportionate share of CAM is to divide the rentable area of the premises by the rentable area of the building. CAM fees vary considerably from one lease to another and include a wide range of expenses.
CAM expenses: What is and isn't included? Most leases include provisions where it is specified that landlords charge their tenants some or all of the costs of maintaining the buildings, including cleaning, landscaping, management services, building insurance, repairs, replacement and utilities. These costs are usually recovered.
Most findings in lease audits do not relate to the landlords' calculation errors but are the result of misinterpretations of the lease provisions. Errors are often due to the inclusion of expenses that are not related to the maintenance, normal repairs or operations of the building.
Common errors. Many mistakes show up in the calculation of CAM and tax pass-throughs.
Here are some examples of common operating expenses mistakes detected during a lease audit:
- Proportionate share miscalculations;
- Charging for excluded expenses;
- Operating expenses not properly allocated;
- Capital expenditures not properly calculated and/or amortized over a period of time that is too short;
- Duplication of costs including after-hour HVAC charges, which are paid by a specific tenant but not deducted from CAM;
- Charges for management and administration that differ from the percentages indicated in the lease;
- Real estate tax refunds not credited to tenants;
- Errors related to rent calculation, rentable area measurement and property taxes charged to tenants;
- Consumer price index miscalculation.
A good deal. As in any litigation, it is important to have a well-documented file when approaching the landlord to negotiate a settlement. Negotiations with the landlord should be undertaken by an experienced negotiator who is familiar with real estate matters.
Before signing an agreement, tenants need to remember the importance of negotiating financial aspects of the lease and also all other terms and conditions affecting the occupancy of the premises. A lease is like a partnership agreement that sets out the parameters of a business relationship.
A well-drafted audit clause should always be included in the lease. Tenants should have the right to audit expenses and review the landlord's calculations.
Lease audits should be an integral part of a company's internal procedures. These audits should be scheduled and executed regularly. Errors found shouldn't be underestimated -- leases run for many years and an error made in the first year could continue over the life of the lease. Consequently, minor errors can result in something significant over time, which provides an opportunity for big savings.