Perhaps one of the most daunting and complex responsibilities of the corporate real estate executive is the management of lease escalation costs. These costs which represent expense pass- thrus from the landlord to the tenant can represent nearly half or more of the cost of tenant occupancy. The complexity of first negotiating favorable expense escalation clauses, and then managing these costs, can create enormous financial and legal penalties for the commercial tenant, unless managed effectively.
What are some of the more troublesome challenges in rental escalations, what I liken to leasing land mines? First, is discovering erroneous or fraudulent expense items that fall outside legitimate building owner expenses. These would include labeling capital expenses as maintenance expenses, costs unrelated to the tenant space such as personnel costs unrelated to the building, and fees and other service costs unrelated to the tenant space. Thus, it’s crucial that detailed expense definitions which form the basis of expense escalations are included in the lease, along with a clear statement of the base year. Too often landlords miscalculate escalations because of erroneous base years, or misused expense definitions.
Another source of erroneous charges relates to miscalculating tenant space as the basis of CAM (common area maintenance) charges. Depending on the specific real estate market, definitions of usable, rentable, and gross space can vary widely and these variances can affect escalation charges by a wide margin.
How can a lease management system assist in the management of escalations? A product like Visual Lease provides a module which automatically flags escalation charges that deviate from the parameters in the lease. This feature greatly reduces the time and effort required in scrutinizing and analyzing escalation charges, and can assist in pinpointing charges that may require specific audit review. Depending on the number of leases, the complexity of escalation clauses, the necessary documentation that needs to be researched about a specific charge, the number and skill of lease administrative staff, all these factors define the magnitude and difficulty of managing escalation costs. A typical corporate lease portfolio of 500 leases will generate at least 30-40 escalation billings per month. While most of the billings will be generally accurate, they will require analysis to validate their correctness before payment. By having the lease management system automatically scan the billings against lease terms, including expense stops, agreed- to expense categories, rate increases, allocations, and other specific terms in the various leases, will vastly reduce the time required to analyze and validate the escalation charges.
As we discussed in an earlier blog posting, there is a real benefit in having a lease audit service combined with a lease management system. This combination provides the capability of bringing in the audit service on particularly troublesome escalation charges flagged by the system. This final line of defense ensures that for major problematic variances in an escalation charge from lease terms, will be challenged with detailed and exacting documentation. The savings to the tenant can be substantial and more than justify the audit fees.
