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After the pandemic brought two-plus years of upheaval, commercial real estate is beginning to normalize. However, amid growing economic challenges — including inflation, rising interest rates and more — and the looming possibility of a downturn or recession, many business leaders are looking to optimize their real estate portfolio. Conducting an annual lease audit is one key aspect to obtain visibility into the operations of the building and provide an opportunity to reduce costs and maximize expense recoveries.
While conducting an annual lease audit helps address those pressing needs, not all lease audits — or lease auditors — are created equal. Results often depend on the auditor’s attention to detail. A successful lease audit program should provide thorough portfolio coverage and full recovery of any costs owed to the tenant while still preserving a positive working relationship with the landlord.
Assessing your lease audit
A lease audit examines a tenant’s lease language and the landlord’s year-end operating expense reconciliation statement. The objective of this initial evaluation is to determine if additional audit work is needed to confirm that operating expense charges were calculated accurately and billed to the tenant in an appropriate manner, in accordance with the intent of the parties, as described in the tenant’s lease.
Tenants need visibility into the operations of properties they occupy. The operating expense charges passed through to tenants recur each year, so it is possible that even a small error and resulting overpayment in a given year will have a multiplying effect over the life of the lease. Even if operating costs are within your budget, an audit is the only way to make sure you do not miss out on opportunities for cost recovery.
- Here are several questions to ask about your business’ lease portfolio:
- Did you conduct an audit for the 2021 lease year? If so, were you satisfied with the outcome?
- Do you think any aspects of the audit could have been improved in terms of process or results?
- Are you confident that you recovered the full amount owed? If you recovered some costs, you may be satisfied with the outcome, but you might have missed out on additional recoveries.
- If you did not conduct a 2021 lease audit, how do you know whether or not you missed out on savings?
Pandemic-related disruption also caused significant changes to the physical occupancy and use of office space during 2020 and 2021. Lease audits for those years have helped tenants gain clarity around how the building was operated and how their landlord calculated expenses, specifically the cost of amenities and how gross-up adjustments were handled, to list just two examples.
Reviewing your lease(s) and audit requirements
Increasingly, many commercial leases require that a nationally recognized accounting firm conduct the lease audit. It may not be sufficient for a certified public accountant (CPA) to simply oversee the audit process. However, many accounting firms do not have deep experience performing lease audits, and very few have a dedicated practice for that service. Experience and dedicated resources make all the difference.
The goals of a tenant when conducting a lease audit can vary. Sometimes a lease audit program is put in place for due diligence, other times the objective is purely cost reduction, while in other situations a company may want to review their entire real estate portfolio to help rationalize costs. With inflation at levels not seen in more than 40 years and the Federal Reserve systematically raising interest rates, more businesses want to review their lease-related costs and obligations in greater depth.
No matter the objective or scope of the engagement, it is critical that the auditor provide a detailed, comprehensive review of all applicable leases. A well conducted lease audit serves the interests of the tenant, but can enlighten a landlord in certain respects, as well. Open and honest communication helps both sides gain a better understanding of each other’s point of view, and serves to strengthen the relationship, especially at a time when tenants are evaluating their real estate needs.
The benefits of a large firm with a dedicated practice of experienced professionals
Often, landlords prefer to deal with a nationally recognized firm with an established track record and deep accounting knowledge. When a tenant retains a lease auditor with substantial resources, decades of experience and a trusted reputation, that helps give a landlord confidence that the process is being carried out properly, professionally, and transparently with the right motivations in mind.
Rather than battling over each cost and potentially creating an adversarial dynamic, an experienced lease auditor — backed by the resources of a large accounting firm — can help reassure the landlord that they seek to confirm that best practices are being followed and achieve a satisfactory outcome for both parties.
Accounting firms abide by specific standards of regulatory bodies, extensive ethics training and continuing education requirements. CPAs go to great lengths to avoid conflicts of interest, whereas other types of lease audit providers may not have such guidelines for their lease audit work. In fact, certain firms that have relationships with large commercial landlords may face challenges when attempting to conduct an objective lease audit on behalf of a tenant.
The necessity of engineering knowledge for lease audits
Lease audits are different from other types of audits, so it helps to have specific engineering knowledge in addition to accounting qualifications. For example, there can be a wide variety of issues related to mechanical engineering that come up during lease audits. The auditor should have a detailed understanding of what is an acceptable standard — both in terms of the engineering best practices and how the issue is typically handled in similar cases. Without in-depth knowledge of building operations, expected cost ranges and common industry practices for landlords, it can be difficult to know what should or should not be deemed acceptable.
Experience as a competitive advantage
Partner-led engagements are important because experience is a primary differentiator. Clients engaging a lease auditor should have a clear understanding of who will actually do the work and communicate with them and the landlord during the process. A lease auditor with a decade or more of experience will be familiar with the nuances and intricacies of the process in a way that a junior auditor likely would not be. There should never be a bait and switch with junior professionals after the contract is won.
Get on the right track with your real estate
What makes a good lease auditor? They have years or even decades of experience in the field supplemented by specific knowledge of building operations, accounting, and mechanical engineering. They also have the dedicated resourced to deliver nimble, responsive, conflict-free services in a manner that preserves and even strengthens the landlord-tenant relationship.
Written by Mitchell Gartenberg and Michael Zwang. Copyright © 2023 BDO USA, LLP. All rights reserved. www.bdo.com
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