Tenants, it’s that time of the year. If your lease is of the type referred to as a “net” lease where a portion of common area expenses are added to your base rent, you’ll be receiving a reconciliation statement from your landlord. Now is the time to review your lease and make sure you understand the expenses and exclusions and how your share is calculated. Things to pay attention to when reviewing your reconciliation statement and analyzing the expense calculation:
Understand the Methodology
Expense reconciliations are often complex calculations where the slightest error can be costly. Check the math, no one is perfect.
Monthly expenses impound. Confirm that the landlord’s accounting records match your payment records.
Verify the landlord is using the correct base year for your calculation. This is specified in your lease.
A good source of information on understanding tenant leases, types and expense calculation is the International Facility Management Association (IFMA) www.ifma.org. Guidance on expense reconciliation and calculation can also be found at various sites on the internet.
Expense Caps
Do you have an expense cap? Expense caps are typically expressed as a percentage but can be calculated in different ways.
What expense items are capped? This will be specified in your lease.
Is your expense cap cumulative on a base year, or year over previous year? Check that it is calculated correctly per your lease.
Pro-rata Share
Specified in your lease, this is the proportion of expenses that are passed through to you and typically is the proportion of the building that you occupy.
Gross-Ups
If your lease allows the landlord to calculate certain expenses as though the building were fully occupied, you need to understand what this means and how your share is calculated. Operating expenses that vary with occupancy levels such as janitorial, certain utilities, restroom supplies and others are subject to gross-up adjustment. Tenants often sign their lease without full understanding of this clause and the effect of changing occupancy levels, especially in today’s volatile real estate market.
Annual average building occupancy is a prime component in gross-up calculations. Low occupancy levels create a multiplier that can create costly errors if calculated incorrectly.
Understand what types of expenses can be grossed-up (variable) and which are passed through without gross-up (fixed).
Real Estate Tax
You can request a copy of the property tax bill from the landlord. This is public information and can also be found online.
Property Insurance
You can request a copy of the property’s insurance bills from the landlord. Check your lease as to what types of insurance expenses can be passed through and confirm the correctness of passed-through expenses.
Common Exclusions
Mortgage principal and interest.
Ground rent.
Capital costs.
Depreciation.
Certain legal fees.
Marketing and leasing fees.
Late fees. For even the most conscientious landlord, it’s nearly impossible to go a full year without having incurred a late fee somewhere. With some landlords its's a common occurrence. You can ask the landlord to show you where late fees are accounted for on their P&L statement and be sure those expenses are not being passed through.
Salaries and employment expenses of personnel above the level of property management personnel.
Hazardous materials abatement and environmental compliance issues.
Since there are many more, consult your lease for what specifically applies to you.
Understanding the expense reconciliation process is challenging but essential. Regardless of your size as a tenant, I advise you to familiarize yourself with the methodology of calculating building operating expenses and reconciliation. Should you require professional consultant review contact us at www.hawthorneconsultinggroup.com.
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