Is your landlord capable of complying with the financial aspects of your lease? In an effort to maximize occupancy and cash flows, landlords negotiate highly variable and complex leases which often vary from tenant to tenant within the same establishment. These leases may combine a variety of terms beyond a fixed base rent, including tenant improvement allowances, rent abatements, common area maintenance expenses, real estate taxes, insurance and other cost allocations.
Interestingly, landlords rarely are equipped or staffed to manage the complexities of their leases to ensure each tenant has been billed properly, resulting in incremental occupancy costs for tenants worldwide. This lack of control is further exacerbated by a market with declining commercial occupancy rates and diminishing rents. Many landlords are looking for opportunities to offload facility management and capital costs to tenants, regardless of the terms of each lease. Often, expenses are passed on to tenants through liberal interpretation of common area maintenance terms or similar expense allocations.
For example, consider an office building that has experienced a 15 percent year-over-year reduction in occupancy. Many of the costs associated with maintaining the facility and providing marketable enhancements are no longer being offset by rents or cost allocations. To maximize cash flows, the landlord may decide to allocate the full costs
to current tenants based on their respective percentage of occupied square footage rather than an allocation based on total square footage. This practice results in nearly 18 percent of incremental occupancy costs for each tenant.
Challenges and Opportunities
While tenants usually are experts in their respective industries, they frequently do not possess the specialized cost control capabilities required to thoroughly review and monitor a complex portfolio of leases and additional rent cost allocations. Additionally, the departments responsible for creating the leases rarely are involved in detailed cost control activities beyond high-level budget monitoring.
The combination of a lack of landlord controls and lack of specialized lease review capabilities by tenants can result in unnecessary occupancy costs in which the tenant is the only party paying the penalty.
In such instances, tenants can benefit from having in place a robust lease cost control and compliance process. Key indicators of the need for such a process include:
- Portfolio of long-term leases (e.g., more than three years) exceeding 20,000 square feet of leasable space
- Leases with complex additional rent and common area articles
- Minimal additional rent and common area maintenance prepayment review processes
— For example, additional rent review processes performed by accounts payable staff rather than experienced lease analysts
Our Point of View
Organizations with a significant level of lease-based spend should implement a combination of preventive and detective controls, including:
- Negotiation of leases by experienced real estate experts to align the terms of each lease with the unique risk factors of each organization
- Standardized review and approval controls that consider the unique risk factors of each lease, to be performed by individuals with specific lease compliance training and knowledge of each lease
- Rotational risk-based audit programs to evaluate lease compliance on a oneto three-year audit rotation
How We Help Companies Succeed
Protiviti offers a variety of lease solutions that are customizable to support each client’s unique needs. Not only does Protiviti help clients to identify and recover noncompliant expenses related to lease occupancy costs, but we also help design and implement processes to prevent monetary leakage related to future transactions. In addition, our lease compliance specialists provide a full suite of lease advisory and management services, including lease negotiation, cost reduction analyses and prepayment reviews.
During its 2009 strategic planning session, a casual-dining restaurant chain with more than 400 locations identified occupancy expenses as a cost-reduction opportunity. Protiviti was engaged to analyze the chain’s portfolio of leases for noncompliant common area maintenance and other additional rent charges.
Within the first few months of the project, Protiviti’s lease compliance specialists identified and recovered noncompliant transactions that exceeded project costs by more than 30 percent. This resulted in a 405 percent return on investment when considering preventable costs over the life of each lease. In addition to identifying and recovering significant noncompliant charges from landlords, Protiviti identified internal preventable costs related to duplicative insurance coverage for in-mall developments due to landlord insurance premiums and client insurance coverage.
Other specific recoveries included:
- Landlord misinterpretation of lease terms – Liberal interpretation of lease terms was resulting in the allocation of expenses exceeding the spirit of the lease.
- Unallowable expenses – Landlord passed on to tenant expenses that were defined clearly within the lease as unallowable.
- Proportionate share misallocation – Landlords allocated additional rent costs based upon incorrect square footage calculations.
- Incorrect amounts billed – Amounts billed did not match supporting documentation.
Protiviti also identified opportunities to renegotiate and clarify various elements within multiple leases, including enhanced audit clause wording, specific identification of unbillable transactions and capital reimbursement caps.