One of the surprises that executives experience is when their landlord sends them a reconciliation statement that asks to send the landlord a check covering last year’s increases in property tax, insurance and maintenance. We call these CAM (“common area maintenance”) reconciliations or CAM recs. This is normal in the commercial real estate world, but the size and type of operating expense pass-throughs are not always what they seem.
With one trucking company client in Fullerton, CA, the lease read that the landlord was responsible for the landscaping costs. Even though the lease said that, the landlord told the tenant that they could take care of landscaping if they wanted, and the landlord would remove that expense from their bill. In practice, the landlord had a ton of property, pooled all of their costs, and wasn’t able to remove this expense on one individual property. That lead to us unknowingly paying for landscaping twice per month for years. The client had figured this out and called me to help them with it. We were able to negotiate a lease extension on their 50,000 SF warehouse that forgave the expense and converted their triple net lease to a gross lease which is almost unheard of in today’s day and age of institutional landlords.
Another warehousing client leased a 25,000 SF industrial building in San Antonio, TX, within a mixed-use business park that included a few Flex buildings with greater than 25% office. In this particular municipality, the county tax assessor took the heavily built out office as a reason to classify the entire business park as a research and development park and assess it at a higher tax rate. It was only with their careful review that we were able to figure this out, contrast it with other landlord’s property tax bills in that municipality and use it to negotiate a favorable relocation.
Lastly, another client of mine in Huntington Beach, CA, received a bill from the new landlord that had just acquired the property from their old landlord. The new landlord was going through a large-scale renovation of the property the entire project. Part of the capital expenses were being inadvertently classified as operating expenses and passed on to the tenants. Here we were able to parse through each operating expense to identify the double billing and bring it to light for an immediate refund and credit to the following month’s rent.
In all three cases, only a thorough review of the reconciliation bill would bring these topics to the foreground. There is language in many leases that are called audit rights. Audit rights are the rights that you have to audit the landlord’s books if you suspect there are inconsistencies.
Most leases allow for some form of a review of the landlord’s books but can sometimes limit who can review the books. It can be the tenant, the tenant’s broker or the tenant’s accountant, or a firm specializing in lease auditing. Some landlords will only allow a certified public accountant to review the books. The size of the space and discrepancy will dictate which you would like to utilize. That said, some leases don’t even mention audit rights. If there is no mention of them, then it is up to us to approach the landlord and determine a reasonable solution.
Much like baseball arbitration in fair market value litigation, there can be risk in contesting CAM reconciliations. In the lease audit process, the final outcome of a lease audit may result in the landlord owing you for accidental or malevolent overcharges, it can also result in an under accounting and additional bill. The mindset you have to have in these types of issues is to think through whether it is worth your time and effort to fight potential discrepancies.
The prevalence of inadvertent CAM reconciliation charges is primarily within the office real estate realm. The reason for this is that in high rise office buildings, the landlord is responsible for providing and managing the building operating systems at their cost and then billing it back to tenants. Building operating systems include the central HVAC, maintenance of the building parking lot, lobby, corridors, restrooms, janitorial, and security services, elevators, boilers, day porters, janitorial services and more. With each additional service that the landlord provides, there is room for error in the quantity and accounting of services offered. While it is true that some landlords can be overly aggressive, we have found that more often than not the problem is human error.
In the industrial real estate realm, the room for aggressive management of expenses and human error is less pervasive than in the office leasing world, but still possible. If you play the game long enough, you are going to come across discrepancies. Being aware of these discrepancies will give you the lens to evaluate each bill and determine what clarifying questions you should be asking your landlord to know if challenging the reconciliation bill is a worthy endeavor.
The best first step is to review prior CAM reconciliation bills and chart them in a spreadsheet to look for trends and discrepancies in each expense category. Look for scale of magnitude inconsistencies first and then annual increase discrepancies second.
The best next step is to ask your broker for industry standards for operating expenses. I know ballpark costs for property management, HVAC, paint, carpet, insurance, office build-out, and sprinkler retrofits off the top of my head. This knowledge is just by virtue of being in the flow of information on industrial leasing transactions daily.
The third best next step is to procure a copy of the Building Operations Management Association’s annual operating expense benchmark report. This report is aggregated by all property managers across the county in office, industrial and retail real estate. This report is a great way to validate your concern and justification to audit. Your broker will be able to procure this guide for you.