Red flags. They are everywhere in life. An email shows up with a suspicious link. A call comes in trying to sell you a car warranty when you already have 140,000 miles on your Pinto. In today’s podcast Bob and Jan delve into 7 red flags that may indicate the need for a lease compliance review.
Today’s topic aligns closely with a podcast we had two weeks ago regarding operating expenses – the bane of a tenant’s life! So, this is the proverbial part 2 because most of these red flags tie directly back to operating expenses one way or the other. Let’s jump right in:
- A Significant Jump in Operating Expenses (also known as additional rent) – some categories of operating expenses may jump up while others are flat or maybe even lower. Taxes, insurance, utilities, repairs and maintenance don’t all behave the same. That said, these items should be reviewed closely every year and especially compared to the year prior and the year before that. Pay close attention to caps on expenses and industry standards.
- Change in Property Ownership/Property Management – this is one of the biggest red flags in my book. A change in ownership may result in new accounting practices and you may have difficulty comparing one operating expense statement from the prior landlord to this year’s landlord. Sometimes, the new landlord doesn’t get good records from the prior landlord. Keep copies of everything you get, share them with your tenant rep and review, review, review! You usually will know the building is selling when you receive an estoppel certificate. Please don’t ever sign an estoppel without your tenant rep reviewing it carefully and possibly your attorney as well.
- Building Undergoing Capital Improvements or Renovations – if you need a hard hat to walk into your space, stop and look around. While these improvements may be wonderful, they should not be your expense. Landlords are more than welcome to improve their buildings, but they shouldn’t pass the cost to the tenants. I can promise you they plan to increase rental rates and that’s where their return should come from.
- Your Lease is Commencing/Expiring – when a lease commences, we want to see exactly what the base year expenses are as each subsequent year may key off of those depending on how the lease is written. Hopefully, your lease has a cap on controllable expenses. If so, the expenses in the first year must be known to properly apply the cap. Always review the lease as you are moving out – there is generally a security deposit riding on it! But the landlord may withhold the return of the deposit until any repairs are complete and the operating expense reconciliation for the last year is completed.
- Sizable Shifts in Building Occupancy Levels – gross up, know it, love it, understand it. Landlords can stipulate in their leases that if the particular building has significant vacancy variable costs they will be estimated as if the building had been fully occupied (or to a stated level like 95%) and use that figure to charge the tenant their prorata share of the expenses. This applies to variable costs only, not fixed costs.
- No or Limited Backup Supplied to Annual Reconciliation Statements – that’s exactly what an audit is – the ability to look at the landlord’s books in detail. Just to be clear, an audit of the landlord’s books and review of their operating expenses are two different things. Normally every year you would, at the very least, review the operating expenses and ask for backup from the landlord. An audit is a much more thorough review where generally a third party is involved and reviews all of the landlord’s expenses in detail.
- Building or Landlord is in Financial Straits – I hate this one and don’t believe it to be widespread but if it happens, tenant beware. Sometimes in that case, landlords will attempt to pass through expenses that are not covered in the tenants’ lease.
As we have said in prior episodes, review your leases early and often! Maybe even audit.
Bob Gibbons is a Real Estate Advisor & Tenant Advocate (also known as a tenant rep) with REATA Commercial Realty, Inc. which is a tenant advisory firm based in Plano, Texas. Bob serves companies in Plano, Frisco, McKinney, Allen, Richardson, Addison, Dallas and the surrounding areas and specializes in companies which lease or buy office and warehouse properties.