There are many factors that can increase the risk of overcharges to a tenant. Most of these relate more to the nature of the transactions than to specific behavior of a landlord, but nevertheless, if a location is in a higher risk category, a tenant would be well-served by investigating the charges with a higher level of scrutiny.
Complex leases
These locations are more prone to error because of the number of moving parts within the documents themselves. Locations can be complex by virtue of a number of factors, including having multiple spaces under different amendments or leases in the building, the presence of multiple expense pools (common for mixed use properties), and having highly negotiated inclusion and exclusion definitions in the operating expense language (such as gross-up language, capital expenditure language, etc.).
Larger / more expensive leases
Although all leases should be subject to routine reviews, as a rule of thumb, all leases over 30,000 square feet should be examined automatically because even small errors can be significant when translated to cumulative liability. Individual expense line items that are more than 15% higher than similar buildings in the same market should also be investigated to determine the reasons for the variance. Leases with significant sundry charges such as overtime HVAC, cleaning or freight elevator use should also be examined closely for those issues.
Leases with significant or unexpectedly high costs
Specific expenses should always be examined when they fluctuate unexpectedly or when they have risen faster than inflation or when they deviate from plan. These abnormalities can be indications that the landlord is not being consistent in its treatment of expenses or is misinterpreting the lease. In addition, leases in which total expenses have risen by more than $0.45 per foot in any one year should be automatically examined.
Leases in buildings where ownership has changed
Changes in ownership often bring changes in methods of accounting and management philosophies. Depending on the type of lease (gross, modified gross, net), these changes can have unintended adverse effects on a tenant’s charges.
Locations where landlord behavior creates suspicion
When a landlord does not reconcile promptly after the close of the year or where prior audits have identified overcharges, the costs should be looked at closely every year. In addition, landlords who do not run their buildings well (slow on maintenance issues, loose controls) are likely to be less diligent in billing their pass-throughs.
Leases where use of the space or physical conditions may impact costs
These include leases in which the tenant has not fully occupied its space or separately contracts for some of its own services. In addition, leases in buildings where construction or capital projects have been taking place during the base year or any of the operating years should always be investigated. Also, even where construction predates the lease term, such construction may impact taxes and other costs that generally lag the activity.
Leases with special provisions
Leases should be looked at whenever certain circumstances are present. For example, leases with new base years should always be examined as soon as the first operating year’s bill is received because these base years determine the tenant’s liability for every year of the lease term. In addition, real estate taxes should always be examined if the property is subject to special tax incentive or tax limitation programs (such as NYC’s ICIP program or California’s Proposition 13) because these programs can distort the consistency and treatment of the tax pass-through provisions. Also, electric rent inclusion, direct utilities, and CPI, Porters’ Wage or other indices should be checked as soon as the bills are received because each has nuances that can easily result in significant overcharges.
Leases subleased out to third parties
Because these leases have two sets of expenses that can have opposite impacts on a tenant, the respective obligations must be mapped out to determine if the charges from the landlord are being properly synchronized with the obligations imposed on the subtenant. A change to a lease’s operating year can have an impact on a subtenant’s base year that can augment (positively or negatively) the amounts payable by the subtenant for the life of the sublease.
Leases within 2 years of termination or renewal
Leases that are close to termination should be looked at before the tenant’s financial leverage is lost. Landlords are more likely to make adjustments if they hope the tenant will renew and/or if significant amounts of rent have yet to be paid. Also, if a lease is approaching renewal, an audit can reveal weaknesses in lease language that can be corrected during negotiations.
Conclusion
These factors can greatly increase the risk of overcharges to a tenant and the presence of any of them should serve as an indication that a more intensive review should be performed.