Ahhh, the joys of managing leases.  It’s like herding cats through a field of mice sometimes. Even though I’m a “dog guy”, we have 2 spoiled, lovable cats that I sometimes think were landlords in a past life, only without the opposable thumbs, Bluetooth device and power of attorney. I’m with America’s largest, most experienced real estate lease recovery audit firm, OAG, The Occupancy Cost Audit Group (can you say plug?) and we identify and recover mistaken overpayments of occupancy costs to landlords on a contingency basis.

At several of our clients, we see a lot of the same mistakes over and over. They engage us to ensure that their real estate occupancy spend is accurate. Many of our clients are the “big guys”, large national chains with hundreds and even thousands of locations, and they have wonderful, competent and totally capable internal audit teams that scour the leases and the associated spend before they turn everything over to us for that last look.  We’re like the free safety in football- the last line of defense, and we’ve made a career of searching behind these busy, sometimes over-worked people to find the valuable needles they’ve lost in their haystacks.

A big part of our findings in audits are in CAM, insurance and tax, but we look at several other areas as well including minimum and percentage rent, tenant improvement allowances, co-tenant and sub-tenant issues and several other areas. In all cases, the signed lease is the total and final guiding document and it is all that a court will look at later should you somehow end up litigating.  We very rarely go to court for a couple of very good reasons:  First, we document everything diligently before we present a claim.  If a client doesn’t want to pursue it, they don’t have to, and this “line item veto” alone saves us all a lot of time and futility.  Second, we’re very reasonable about working out a settlement and finding a creative way to get a refund or future credit for our clients.  If a landlord is completely wrong about an overpayment, and refuses to work with us, then occasionally our clients will deduct, but again this doesn’t happen very often.  It’s in everyone’s interest to resolve claims amicably and professionally, and keep the business going and generating revenue.

Many leases require tenants to pay a big share of the landlord’s operating costs.  To limit your expenses, you need to be vigilant in reviewing the costs passed on by your landlord.  Successfully fighting overcharges requires that you take 3 steps:  1) read and understand your operating cost clause, (2) review the facts and (3) convince the landlord that your claim is valid and that you are ready to enforce your rights.  In this article, I’ll give you an overview and discuss some overcharge claims that you might not have thought about, and we’ll assume that your  leased location is in a mall, strip center or other area with co-tenants.

A lease’s operating cost clause usually defines the costs passed through to the tenant. Too many times, we see landlords charge all of their tenants for costs using the same formula.  But your operating cost clause may be very different from other tenant’s clauses and your lease language prevails.  If your operating costs are not fixed, there are many variables that go into calculating your share of costs.  It is very important that you read and understand your operating cost provision when reviewing the charges passed through to you. 

You must closely review the different charges that your landlord may rightfully pass on to you. The operating cost clause might state, for example, that you are bound to pay a percentage of “the costs of maintaining, managing and operating” a location.  Many times, the clause lists certain types of expenses that are included in the definition of operating costs.  This list may be exclusive, or simply be illustrative (i.e., “operating costs include but are not limited to”).  The clause may also contain language excluding certain costs related to certain parts of the building. It might also exclude certain categories of costs, such as capital improvements.

One important question to ask when reviewing your operating cost provision is whether it is truly an operating cost clause- allowing the landlord to pass on the costs associated with operating and maintaining the center as a whole- or whether the landlord can only pass through common area maintenance expenses (CAM). If you are only required to pay CAM costs, understand how the common areas are defined in your lease. You should also pay particular attention to definitions: Are walls and roofs included in the “common area”?  Is your valet parking area used by other businesses, or only yours? The definition of the common areas helps determine what expenses may be passed on. 

You should understand and ensure that both the numerator and denominator set forth in your operating cost clause are correct.  These determine your percentage share based on the total leasable space in the shopping center.  This ratio should hold true throughout any of your percentage share calculations for a property.  Is your percentage share calculated on the total leasable space in the shopping center or only the occupied space?  If it’s based on occupied space, then the landlords can sometimes get really shifty with the math as clients move in and out and in again.  After awhile, the math becomes almost impossible. Knowing the differences in your lease clauses can make a big difference in calculating your proper share of operating costs.  Once you understand the language of your operating cost clause, you will need to investigate the facts.  You can gather some information on your own such as if your denominator is based on the amount of space leased in the shopping center, and you can monitor when new tenants move in to vacant space.  This area is a favorite of landlords who are often slow to update this percentage to your favor. Yet, much of the information relating to operating costs are under the landlord’s control and if you suspect an overcharge, you’ll need to write a request for supporting documents.

We find these requests are almost universally ignored the first time around.  It’s the landlord’s first line of defense and often it’s effective.  They pull up the drawbridge, close the castle gates and ignore your polite and professional letters and emails.  You just have to persist, and continue to be polite.  We find that “polite persistence” works about 95% of the time and the other 5% of the time you’ll need to use the catapults and flaming arrows.  Your lease may explicitly provide that you have the right to audit operating costs so cite that provision if so.  Your lease may set limits on your rights by limiting the time period for which you can ask to audit. If your lease is silent to your rights that does not mean you have no other options and you should still request backup from your landlord. There is fairly strong legal precedent for you to ask for and receive such backup even when the lease is silent. (Courts love tenant’s rights for the most part, or at least are quite fond of them).  

Case study- Here’s an actual claim letter for recovery of administrative fees and CAM:

Dear Landlord,

 As part of our ongoing internal audit program, we routinely review documentation supporting CAM and taxes charged to our leased locations. We have determined that, for the six years ended 7/31/12, we incurred $63,614 in charges for which we are not liable pursuant to the terms of our Lease.

 

Item	To
1. Excess   CAM and Tax Pro Rata Share Costs	$ 55,421
2.   Administrative Expenses	$   8,193
Excess   Charge to	$ 63,614

 

1. Excess CAM and Tax Pro Rata Share Costs- $55,421

Pursuant to Article X of the Lease – Taxes “Tenants proportionate share shall be the fraction whose numerator is the total square footage of leasable floor area of the Premises and whose denominator is the total square footage of the leasable floor area of all buildings located in the Shopping Center.”

Pursuant to Article Y of the Lease, (Additional Rent – Maintenance of Common Area and Tenant’s Contribution) “Tenants proportionate share shall be that fraction whose numerator is the total square footage of the floor area of the Premises and whose denominator is the total square footage of leased occupied first floor area of all buildings located in the Shopping Center.”

In this fully occupied Shopping Center, the leased and leasable areas are essentially the same. However, in computing our Pro Rata Share of both CAM and taxes, you used a much smaller denominator which substantially overstated our Pro Rata Share and resulted in our incurring $55,421 of excess costs for the six years ended December 31, 2012. (Please see Exhibit for details.)

2. Administrative Expenses- $8,193

Pursuant to Section Z of the Lease, Additional Rent – Maintenance of Common Area and Tenant’s Contributions, “Tenant shall pay to Landlord Tenant’s Proportionate Share of… Administrative costs equal to fifteen percent (15%) of the forgoing costs”. In fact, you charged the aforementioned 15% fee annually. However, in addition, you charged $421,550 of Administrative Costs of which we paid $8,193.

Year                  Costs

2007             $ 80,789

2008                83,288

2009                85,864

2010                50,585

2011                54,868

2012                 66,156

TOTAL        $ 421,550

 

Please provide me with a check, or credit, for $63,614.

Sincerely,

Your Favorite Tenant

If your right to audit is limited that does not mean your right to sue your landlord is also limited to the same time    period, because your money does not expire!  That’s our general outlook, anyway, not a legal theory, but there is a legal concept called “consideration” and that basically says in a contract that one party can’t demand something without giving something in return, and when leases take away your right to audit, they’re not giving anything in return.  It gets complex, but that’s the short explanation. Unless you explicitly waive the right to sue for overcharges after a certain period, your claims will likely only be limited by the relevant statute of limitations.

After you’ve read your lease and weighed the facts, it’s time to present your claim in writing.  You may need to retain counsel but sometimes just a letter from your lawyer on letterhead is enough to nudge the landlord to settle your claim, especially if they may be held liable for legal fees.

There are a lot of ways your landlord can overcharge you and some are fairly easy to understand, such as when they incorrectly figure your denominator to determine your percentage share of costs.  If you’re only required to pay for CAM costs, you should challenge any costs not related to maintaining the common areas of your center. But other claims might not be so obvious.  For example, can your landlord charge a management fee, or a supervisory fee or an administrative fee?  Those rascally rabbits!  This is one of the big areas landlords fudge it and it really pays to have uber-specific language defining what the landlord can charge for these fees.  This fee can be based on a set percentage of total costs or CAM costs and your lease may or may not permit these.  It may also represent what a landlord pays to a management company, typically a closely affiliated working partner or firm. They definitely have each other on speed dial if you get my drift. 

When your lease authorizes landlords to impose such fees, you need to understand it well. Your lease might state that you are required to pay a percentage of all CAM “plus a fee for supervising the common areas in an amount equal to 7.5% of CAM costs”. But if your lease is silent, there could be a good basis to challenge any fee. In one court case, a tenant sued its landlord claiming the LL wasn’t allowed to charge a management fee and the court found that the fee charged by the LL was not a common area expense but an overhead cost which the LL was not permitted to pass through.  If your lease does not expressly mention a management fee, you should look to the rest of the operating cost clause and related provisions because you may have a stronger case for challenging management fees if you are responsible for a share of “operating and maintaining the shopping center” rather than “operating, maintaining and managing the shopping center.” 

You might also contest management fees if your lease specifies that the landlord can only pass on costs that are actually “incurred by” the landlord.  If a landlord imposes an added 15% charge, you might argue that such a charge is not a cost “incurred by” the landlord and doesn’t represent an actual expense but rather an arbitrary surcharge.  Sometimes a management fee will duplicate other charges under a lease.  Landlords have been known to charge tenants both an administrative fee explicitly permitted and an additional management fee, effectively double-charging for the same activities.  If your landlord is allowed to charge a fee per the lease, you should still review your operating cost clause to ascertain if you’re obligated to pay the entire fee.  If you’re only on the hook to pay a share of the CAM costs, the landlord can’t charge you a management fee to run the entire shopping center operation.

 Case study- Right to audit letter to a landlord

Dear Landlord:

Thank you for your response to my letter. I’ll respond to your comments in the order raised in your letter.

1. Right to Audit – You indicated that we could only audit the Operating Expense Reconciliation for the latest three years and, if we had decided to conduct an audit of the Accounting records at your Home Office, you would be correct in providing the Accounting records for only the latest three years. However, we have not conducted an audit, but rather we merely reviewed the Lease of our , the Reconciliations and other documentation in our possession or supplied by you at our request. This is not an audit, but merely due diligence regarding amounts for which we have borne the cost and the only time limitations is the six years contained in the Statute of Limitation of the State.

2. Management Staff – Your response is somewhat confusing. First you state that “Management Staff”, is not a charge for management but rather for an exterior staff that performs maintenance at the center. Are you saying that the “Management Staff” is really a maintenance payroll? Then you indicate that “Management Staff” is really for management personnel but is allowed under the Lease. The simple fact is that the “Management Staff” does represent the management payroll that has already been reimbursed via the Management Fee. Please note that Section X of the Lease limits your reimbursement to “all sums expended or incurred in connection with paid Common Area for all general maintenance and repairs.” This is a duplicate billing and we are due $104,271 on this issue.

3. Other Grounds – The cost of “Landscaping Maintenance” $174,000 is extremely high for a Shopping Center of this size. The landscaping contractor, especially one receiving a high level of compensation, would routinely police the grounds and remove any paper, bottles, trash, etc. Also in response to Point 2, “Management Staff”, you indicated that there was another group of employees policing, cleaning up, sweeping, etc. Now you are saying that in addition to all of those individuals, there is another group, covered by “Other Grounds” out there cleaning up the sidewalks. “Other Grounds” represents a duplicated charge and we are due $37,947 on this issue.

4. Common Area Tax – In your letter, you indicated that we are obligated, pursuant to our Lease to pay taxes on the Common Area. We are completely in agreement with you on this and, in paying 100% of the tax on each of the two parcels, we are fulfilling our lease obligation because both parcel 000-01-0001 and 000-02-0002 contain common area in addition to the two Premises. We are due $14,887 on this issue.

5. Non-Irrigation Water – The charge for Irrigation Water, $74,000 to $88,000, is “off the charts” and greatly in excess of any of the water costs we sustain in our other locations. Based on the magnitude of this charge, it obviously contains more than “Irrigation Water”. Also, the variance in the monthly cost of the meter #3688 varying from $45 to $4,500 is obviously wrong and not reflective of changes in weather conditions. The whole scenario surrounding total Irrigation Water charges is obviously questionable and we are due $11,439 on this issue.

 

Please provide me with a check, or credit, for $167,640 or we will turn this matter over to our General Counsel for further action.

 

Sincerely,

Your tenant

Are certain revenues offset against operating costs? Sometimes, landlords generate revenues in the common areas of the center such as parking fees, concierge services or concession sales in common areas.  Your lease may say that such revenues should be offset against your share of costs.  You can also argue that costs incurred in revenue-generating activities, such as the salaries of valet parking attendants, should be excluded.  You should question whether you’re paying for costs such as electricity used to power advertising kiosks or vending machines.  These aren’t costs incurred in operating the center or common areas but rather lining the landlord’s pockets. 

Making a successful claim for operating cost overcharges starts with reading and really understanding your lease and the language in it.  Think carefully and creatively about charges your landlord might be passing through that they shouldn’t, and follow through by determining the facts and presenting a convincing case to your landlord.  You might see some large savings in your future. 

Kirk Morgan is with OAG, The Occupancy Cost Audit Group (www.oaginc.com) and can be reached at kirk.morgan@oaginc.com.  Tracy Reichmuth is with Crowell and Moring, LLP in San Francisco, CA.