A major component (30% or more) of an office tenant’s rent bill is property taxes & operating expenses (“T&O”) which today is on the rise and where tenants have limited control under landlord-favorable leases. In Chicago, T&O is rising significantly and where most buildings quote rents on a “net” basis (which may be comparable), the amount of T&O can vary significantly among buildings. While tenants and their advisors will fight hard on the rent and other deal terms, if T&O is not properly vetted and negotiated, those deal terms will be far outweighed by surprisingly large T&O costs. In this post, I discuss the two common rent structures and offer strategies on limiting increases in T&O to provide tenants with cost certainty.
Now that the holiday season is over, ‘tis the season for Operating Expenses and Tax reconciliation for office tenants. As most office leases allow the landlord to recapture increases in Operating Expenses and Taxes (which tenants commonly pay on an estimated basis over a calendar year), landlords are required to reconcile the year’s actual expenses and taxes to the tenant’s estimated payments. That reconciliation statement is typically issued in first quarter. If not carefully reviewed by a tenant, in all likelihood money is being left on the table as 90% of these statements have some errors. This is particularly important in cities like Chicago where tenants are seeing major increases in property taxes. While there’s not much a tenant can do with rising property taxes, they can lessen that blow by closely scrutinizing the operating expenses. Now, more than ever and in light of the new accounting standards, tenants must be aware of their occupancy costs and diligently pursue their audit rights. Outlined below are strategies tenants should employ in reviewing these statements as well as some ideas on how to craft these provisions in future leases. I am joined on this post with Mirela Gabrovska of MBG Consulting, a national expert in lease administration and auditing.
Responding to the need for greater transparency in financial markets in the post-Enron era, a new accounting standard is being presented requiring tenants (both public and private companies) to recognize the current and future value of all leases on their balance sheets. This standard is jointly presented by FASB (Financial Accounting Standards Board) and IASB (International Accounting Standard Board). The proposed standard, if enacted, will be a factor in the real estate decision-making process for all companies. It will have a major impact on financial statements of companies with large lease obligations which are currently considered “Operating Leases”. While this proposed standard applies well beyond the lease of real property, my focus is on its impact to tenants in office leasing. It has been reported that this change will result in between $1 and $2 Trillion being transferred to companies’ Balance Sheets. Some question the timing of this proposed change given the economic conditions and the state of the commercial real estate industry.
All forward thinking tenants should review with their real estate advisor how the proposed standard will impact their real estate strategy. Below is a summary of the current accounting standard, the proposed new standard and its impact on office tenants.