Cresa Blog

OPEX: The Hidden Costs, Part II

Friday, February 18th, 2011

By Jason Jones and Kathy Burke, Principals

In Part I, we gave an overview of operating expenses—what they are, what tenants should know about them, and when tenants should be concerned about an operating expense statement from their landlord.  In Part II, we will continue the discussion.

The following issues are often predictive of errors and overcharges:

-Substantial capital improvements made within the past year. If improvements have been made to the building during the year, pay very close attention to make sure that the treatment of your operating expenses is recorded according to generally accepted accounting principles (GAAP). For instance, if a new roof is put on the building, or if the lobby was renovated, these types of expenses should be capitalized and, in the case of most leases, excluded from the operating costs charged to tenants.

-Transfer of the property to a new entity.  New owners will often implement their own accounting practices and methodologies.  In the event of a refinance or sale, it is not uncommon to experience significant clerical mistakes made because the new owner did not properly read your lease.   

-Increased vacancy in the building. Vacancy frequently leads to errors and overcharges as a result of the landlord’s process of extrapolating the building’s expenses to reflect what they would have been at full occupancy (commonly referred to as a “gross up”).

What can tenants do to mitigate expenses?

Since you do not control the operation of the building, you need to rely on the professional expertise of the landlord. The items that a tenant can control are typically limited to your HVAC and electric consumption. Keeping thermostats at a reasonable temperature and turning off lights or, better yet, having light sensors installed can help.

Another way to mitigate your expenses is to have a well-negotiated lease document with the right to audit operating expenses. Without this right, you have limited recourse should expenses escalate rapidly.

Many companies perform annual audits as a matter of business practice. This practice alerts everyone that attention is being paid to this issue and increases the level of accuracy. Historically, 80 percent of reconciliation statements contain items that require further clarification, with 25 percent of those statements material enough to warrant an in-depth audit.

What should you ask for from your landlord?

The landlord should be able to provide documentation confirming what was budgeted as well as the actual expenses incurred. This documentation should include a detailed line-item statement with an explanation, by account, of the actual versus budgeted expenses.

It is not unreasonable for the tenant to request at least two prior years’ worth of history, if you have had the same landlord or property manager. This historical data will help you ascertain the validity of the charges, category by category.

Tags: corporate real estate, landlord, lease, opex, tenant
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OPEX: The Hidden Costs, Part I

Wednesday, February 16th, 2011

By Jason Jones and Kathy Burke, Principals

Much like a residential home, commercial office buildings experience normal operating expenses (OPEX) such as taxes, utilities, and ongoing maintenance charges.  And, as is the case with a home, the occupant is billed for these expenses on a monthly basis.

Every year, landlords provide tenants with their annual operating expense reconciliation statements.  This statement is basically a “true-up” of the actual costs incurred by the landlord versus the costs budgeted and already paid by the tenant. When you receive this document, it would be worthwhile to take a closer look to confirm whether or not the charges are appropriate.

In spite of everyone’s best efforts, there are often mistakes within these documents. Aside from mathematical errors, it’s important to realize most landlords issue their reconciliations based upon the “standard” lease, and your lease may deviate from that standard. 

What should tenants know?

A well-negotiated lease document will clearly define allowable operating expenses, detail proper accounting treatment, and specify which costs are not allowed to be charged to the tenant. Typically, “operating costs” include your real estate taxes, cleaning, common area maintenance, building insurance, management fees, and repairs that had to be done during the year.

In practice, your landlord will estimate property expenses for the upcoming calendar year. Tenants pay their percentage share each month throughout the year, based on the budgeted amount. At the end of the year, the actual expenditures are calculated, and during the first quarter of the following year, the landlord will deliver an annual reconciliation statement.  Over the course of the lease, these adjusted operating expenses can become a significant expense that should, at the very least, be reviewed and justified. Note that there is enough gray area in calculating operating expenses that entire businesses exist just for the purpose of auditing these costs for tenants.

When should tenants be concerned?

If the expense numbers appear excessive, you should ask your landlord for an explanation, subsequently following up with your real estate adviser to confirm whether or not they are consistent with the market. 

Often, the best way to ensure accuracy is to request that your real estate advisor perform a “desk-top” audit. The first indicator of a billing error is an excessive percentage increase from your last year’s operating expense statement. Note that with the exception of taxes, insurance, utilities, repairs, and maintenance (based on the age of your building), it is customary for most categories of operating expenses to escalate less than 5 percent per year. Anything beyond this number requires further clarification. If you reach a double-digit number, an explanation is due.

Stay tuned for Part II, where we will discuss issues to look out for, what tenants can do to mitigate expenses, and what tenants should ask their landlord for.

Tags: corporate real estate, landlord, lease, opex, tenant
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