Tenant lease reviews: are you over-paying your landlord?

Internal Auditor, August, 1996 by Alan Jacobson

Businesses, through a tenant lease review, can often recover one tenth of one percent of all occupancy costs incurred during an audit period. Tenants may be able to identify discrepancies that could return anywhere from tens of thousands to hundreds of thousands of dollars in misspent funds to the company's coffers. In the past, companies may have had the luxury of choosing not to spend their time and resources in reviewing and recovering the overpayments; but in today's downsized, rightsized, reengineered, and restructured business environments, recovering misspent funds is a matter of survival.

* The Tenant Lease Review

The purpose of a tenant lease review is to identify inconsistencies between what the lease agreement obliges the tenant to pay and what the landlord actually charges. Overcharges can occur or go unnoticed for several reasons:

1. The individual who approves the occupancy payments is unfamiliar with the details of the lease agreement.

By the time lease negotiations are concluded, the various revisions, amendments, addenda and related real estate documents can bring the lease agreement to more than 100 pages. When the rent statements begin arriving, however, a tenant's property accountant or the accounts payable department probably reviews the invoices using a lease abstract, which is a one-to-five-page summary of the full lease agreement. Because the abstract does not reflect all of the subtleties contained in the full agreement, tenants often end up paying more than they had agreed to pay.

For example, a business owner and his landlord negotiated a lease agreement for a 150,000-square-foot retail store that was yet to be built. The agreement provided for common area maintenance charges (CAM) and property taxes to be billed based on the square footage. After construction, the store contained only 125,000 square feet of space, but the lease abstract remained unchanged. Unaware of the discrepancy, the accounts payable department paid the higher pro rata share that was being charged by the landlord, resulting in an overpayment of $84,000 in CAM costs and property taxes over a two-year period.

To identify such errors, the auditor should compare the actual leases, including amendments, to the lease abstracts used by accounting. By doing so, the auditor can determine whether or not the abstracts contain changes reflected in the lease amendments. In the example cited, an addendum or amendment to the original lease should have reflected that the store contained only 125,000 square feet instead of the 150,000 square feet planned.

2. The invoice includes inappropriate charges to common area maintenance.

The CAM expense is intended to be the tenant's pro rata share of the pass-through of the landlord's reasonable costs of lighting and securing the common area and maintaining it in a neat, clean, and orderly fashion. With CAM costs on the rise, tenants may sometimes feel as if the landlord regards the common area as a profit center. This is inaccurate in most cases, but lax accounting by some landlords tends to lend credibility to the idea.

For example, a tenant was billed for an incorrect share of the common area insurance costs. A review of the master insurance policy, which covered several properties owned by the same landlord, revealed the discrepancy. The misallocation resulted in some properties being undercharged, while the tenant was being overcharged. The correction of this problem, along with several other inappropriate charges, resulted in the recovery of several thousand dollars by the tenant.

To detect such misallocations, the auditor should review the Certificate of Insurance, which indicates the types of coverage, areas covered, and limits of coverage on the property. The auditor should also ask the landlord for a copy of the allocation of the master insurance policy premium costs. Generally, the amount allocated to each property should relate to each property's portion of the gross leasable area of all of the landlord's properties covered by the policy. Of course, allowances should be made for different types of properties covered by the master policy.

3. The invoice overstates the tenant's share of pro rata expenses.

The overstatement of a tenant's share of expenses frequently occurs when there is an addition of gross leasable space to the shopping center and the landlord neglects to increase the denominator of the pro rata share calculation. Total expenses divided by a larger number of tenants should mean that each tenant pays a smaller fraction of the costs; but if the denominator is not adjusted, existing tenants pay more than their share.

Overpayments also can result from a confusion between gross leasable space and gross leased space, terms that are used to determine a tenant's share of maintenance expenses. If the lease agreement calculates these expenses based on gross leasable space, a tenant pays its share of the maintenance costs based on the percentage of the total leasable space in a building that it occupies, regardless of the vacancy rate. If this calculation is based on gross leased space, however, the tenant's share of maintenance costs is based only on the percentage of space that is currently occupied, which means that the tenant must absorb the CAM costs attributable to the vacant space. The difference can be significant.