Lease Audits: Benefits of
Outsourcing
Tight market conditions are permitting
commercial landlords to raise rental rates to record levels. From tenants'
point of view, it is vital that they utilize all opportunities to keep
overall facility costs as reasonable as possible. The best hope for tenants
in this regard is to periodically audit their leases to assure that lease
provisions are being correctly adhered to and billings are free from
overcharges or errors. Lease audits, by which qualified experts verify the
accuracy of operating expense pass-throughs, real estate tax contributions
and any other charges other than basic rent, have become a service
increasingly performed by outside vendors rather than in-house.
Within the past decade, lease audits have grown from a very small niche
market with few participants nationwide into a segmented industry with
several large national participants and dozens of small local firms
specializing in their particular market region. The rapid growth of lease
audits has been due both to the cost-cutting measures of many corporations
in the face of difficult market conditions as well as the realization by
many office tenants that expenses and pass-throughs were not being properly
billed. And every audit that produced savings for the tenant brought new
business to the lease audit specialist.
When lease audits first began to be performed by outside professionals, the
exercise often proved to be not much more than a standard due diligence
procedure. Professionals who functioned as general auditors lacked the
specific knowledge of real estate and familiarity with tenant/landlord case
law to successfully realize savings from audits. Still, this represented an
important step forward from the practice of performing lease audits by staff
members of a firm who usually lacked the training, resources and time to
adequately address the challenge of analyzing complex lease provisions and
oblique billing practices of landlords.
Advantages of Outsourcing
The advantages of outsourcing lease audits rather than doing them in-house
are easily recognized when certain considerations are made clear with
respect to the audit process. First of all, most lease audit firms perform
their services on a contingency basis, thereby absorbing all of the
financial and time-related risks involved in an audit. By one estimate, the
average field audit encompassing the initial review through the final report
submitted to the tenant after an inspection of the landlord's books and
records can take between 50 and 60 hours. The estimate does not include
additional time spent negotiating with the landlord to actually realize the
savings—this often being the most time-consuming part of the process.
Lease audit professionals, with their extensive knowledge of lease clauses
and market practices, are in a position to identify lease audit candidates
that have a high probability of a substantial recovery. This permits them to
avoid spending their resources in auditing properties with a low probability
of recovery. As a result, even when a lease audit professional declines to
take on a particular tenant, the tenant has learned that it may not be
worthwhile spending its own resources in seeking errors in the lease.
A further advantage in having outside professionals perform a lease audit is
that a second and independent set of eyes review the lease and billing
invoices of the landlord. Too often, in-house lease administrators are so
familiar with the files they deal with daily that they pass over indications
of possible errors. It is for this same reason that many lease audit firms
have a second auditor review a file for overlooked or unidentified
opportunities for savings. In addition, most lease auditors specialize in
certain areas such as accounting, law, electrical and other utility
services, and architectural and engineering subjects. A lease audit firm is
able to draw upon various individuals who have the necessary knowledge in
each subject.
Landlord/Tenant Relationships
A consideration to be borne in mind by a tenant when deciding whether to use
in-house auditors or engage outside professionals relates to the
relationship the tenant wishes to have with its landlord. Some tenants are
concerned that engaging an outside firm to conduct an audit will result in a
confrontational relationship with the landlord. Although this can occur,
most landlords accept the right of a tenant to examine the landlord's
records relating to rent and other charges. It is more likely that the
landlord would prefer to deal with an outside auditor who will conduct a
review efficiently and in a minimum of time. Even in situations when the
magnitude of the claim creates a level of acrimony between the auditor and
the landlord, prudent tenants that have utilized outside professionals are
able to insulate themselves from any unpleasantness, and indeed may be in a
position to step in and help to negotiate a satisfactory settlement.
A final consideration with respect to maintaining a relationship with the
landlord arises when the tenant and the landlord have a contractual or other
relationship separate and apart from the landlord/tenant relationship. While
this can be a very sensitive concern to the tenant, he should bear in mind
that rent and lease escalations are second only to payroll for most
corporate tenants and should be reviewed just as is any other invoice sent
by a vendor.
Real Estate Focus is provided by Somerset’s Real Estate Team for our clients and other interested persons upon request. Since technical information is presented in generalized fashion, no final conclusion on these topics should be made without further review. For additional information on the issues discussed, please contact Michael Fritton, CPA. Whether you are a building owner, building manager, real estate developer, real estate professional, or an investor, we hope to provide you with timely information so you may be proactive in making your business decisions.
This article was written by and published herein with the permission from professionals of BDO Seidman, LLP. David Tevlin is Managing Director of Corporate Real Estate Services in BDO Seidman's New York office. Somerset is a member of the BDO Seidman Alliance, a nationwide association of independently owned accounting and consulting firms.
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