Magazine article Journal of Property Management

Mind [Left and Right Arrow] the Gap: Advice on Designing Lease Audits That Harness Lost Revenue and Promote Positive Tenant Relations

Magazine article Journal of Property Management

Mind [Left and Right Arrow] the Gap: Advice on Designing Lease Audits That Harness Lost Revenue and Promote Positive Tenant Relations

Article excerpt

Often the first thought that comes to mind when a landlord or property manager hears the words "lease audit" is a tenant-initiated, contentious and protracted lease review process that raises blood pressure and heart rates. While lease audits can be extremely costly and jeopardize an otherwise good landlord-tenant relationship, landlords and managers should consider taking another look at the practice, which cannot only generate meaningful revenue and significant cost recoveries, but also provide a proactive tool to avoid potential conflicts with tenants.

What Does a Lease Audit Identify?

Stated simply, a landlord lease audit is a comprehensive and detailed review of the leases used in connection with the commercial office, retail or industrial properties in a portfolio. Lease audits are typically performed on the landlord's behalf by an outside auditor to ensure all revenue-generating and cost reimbursement provisions of the leases are properly interpreted, calculated and implemented by the landlord or its manager. Lease audits will often reveal costs and expenses a landlord is paying, which, based on the requirements of the lease, could legitimately be passed through to tenants. Audits often identify inadvertent mistakes made in the interpretation or calculation of rent escalation and other revenue-generating lease clauses. Essentially, a lease audit enables landlords to maximize the revenue stream from rental assets by not only ensuring all rent payment clauses are being adhered to, but also by confirming all eligible expenses are passed through to tenants.

To the extent they reveal billing mistakes, particularly tenant overcharges, lease audits can also enable landlords to correct existing errors in advance of any claims by tenants. This approach allows landlords to avoid potentially costly litigation, as well as unanticipated tenant reimbursement obligations for what can often be significant dollar amounts that can decimate an asset's annual budget. From a forward-looking perspective, lease audits permit landlords to implement practices and procedures designed to target errors and ensure such errors are not perpetuated, essentially preventing tenant overcharges before they happen.

Why Perform an Audit?

Given the complexity of most commercial lease agreements, it is not surprising they present a number of opportunities for potential errors. Jeffrey Strauss, a principal at New Jersey-based Schonbraun Safris McCann Bekritsky & Co., heads the firm's national lease audit practice and frequently finds a variety of mistakes through the landlord lease audits he conducts. According to Strauss, many errors arise because lease provisions are not properly implemented, lease language is misinterpreted, critical data relating to the calculation of rent or determination of operating expenses are incorrectly entered or landlords inaccurately calculate rent numbers or cost reimbursements.

Which Clauses Need to be Reviewed?

Any lease audit conducted for the benefit of the landlord should examine each and every clause in the lease that bears on the calculation of rent to be paid or expenses to be reimbursed by a tenant. The most obvious revenue-generating lease provisions relate to the calculation of base rent and percentage rent, including the determination of breakpoints. Clauses relating to rent escalations, particularly those tied to increases in the Consumer Price Index or other cost-of-living increases (as opposed to fixed annual percentage increases), are also worthy of review, as are the determination of renewal rental rates upon extension of a lease term and the method for determining a landlord's share in any sublease profits or lease assignment payments.

Because so many expense reimbursement provisions are typically included in a lease, Strauss recommends landlords and managers use an experienced auditor to review the calculations for each and every expense provision, especially those relating to operating expenses passed to tenants for a triple net lease, or operating expense increases for a full-service lease (specifically, the proper calculation of "base year" expenses). …

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