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Outsourcing of lease pass-through growing.

A growing number of U.S. companies are turning to outside sources to handle their lease pass-through analysis, according to a Coopers & Lybrand survey.

Companies that used this service saved an average of $.50 to $1 per square foot of leased spaced annually, according to the survey, equivalent to as much as $600,000 over five years for a 120,000-square-foot building, the typical size for those surveyed. The survey was conducted by Coopers & Lybrand's Real Estate Advisory Services group with over 30 clients who have used this service.

Lease pass-through analysis, which is the review and analysis of operating expenses and real estate taxes that landlords prepare and bill to tenants, has become an increasingly important method for reducing and controlling occupancy costs, according to Coopers & Lybrand, the most active of the Big Six accounting firms in this area.

The firm found that the recession has heightened companies' sensitivity to costs, leading many to seek outside sources for lease pass-through analysis. Companies that experienced record sales and profits in the early to mid-1980's have shifted their emphasis from expansion to streamlining of their operations. Yet many of these organizations have obligated themselves to blocks of space for a number of years to come. At the same time, facilities managers have been hit with personnel reductions.

"Over the years, landlords have found that most tenants do not have the resources to analyze the lease and additional rent bills, verify the actual expenses and then follow up and obtain a recovery of overpayments," said Dr. Bjorn Hanson, Coopers & Lybrand's National Real Estate Industry chairman.

He notes that landlords typically have taken a very aggressive posture when preparing operating expense and real estate tax billings. "Even if a single tenant were to perform an analysis and recover a sizable sum, the landlord would still continue the aggressive billing to the balance of tenants," Hanson added.

As a rule, lease language defining operating expenses, real estate taxes, and the mechanics to be used to bill tenants, is not all inclusive or objective, according to Patrick Leardo, partner-in-charge of C&L's Real Estate Advisory practice. Two specific areas where problems arise are in "gross-up" language and exclusions.

'Gross-Up' Issues

Sophisticated facilities managers have negotiated leases with certain protective clauses called "gross-up" language. The purpose of the gross-up language is to protect tenants by adjusting actual base year operating expenses and real estate taxes to reflect the costs that would have been incurred if the building were fully-occupied and fully-assessed. Although tenants expect to pay their share of cost increases due to inflation and normal wear and tear, those tenants who occupy partially vacant space may be overcharged for escalations as the building is leased up. Certain operating costs and, as such, increase with increased occupancy. Additionally, real estate taxes (especially on a newly completed building) increase as the assessed value on the building increases. building assessments on newly completed buildings are phased in over a number of years, usually matching the time associated with leasing the building up to stabilization.

Even when gross-up language exists, it is usually open to a significant amount of discretion by the landlord. A tenant must analyze the landlord's approach to the gross-up of certain expenses to ensure that the intent of the lease has been considered, Leardo says.

Exclusions

Exclusion language specifies which expenses incurred by the landlord are not to be passed along to tenants. Exclusions typically include the following:

* Capital improvements

* Leasing costs (including commissions, space planning, legal and other professional fees associated with new leases or pursuit of delinquent tenants) o Tenant-specific charges or expenses

* Landlord salaries above the grade of building manager

* Management fees above the customary percentage for that locale

Coopers & Lybrand's survey found that rent bills often reflect costs specifically excluded by the lease, requiring detailed analysis to uncover. Even when the lease is silent regarding exclusions, Leardo advises tenants to confirm that their charges cover only costs which are of value to the building's occupants and are not "typical and customary" exclusions for billing purposes. Firms that choose to analyze lease charges could recoup a substantial sum. For example, one Coopers & Lybrand client had noticed that a significant proportion of its passthrough expenses were related to real estate tax escalations. Base-year real estate taxes were defined as the year in which the building was assessed as "fully improved and/or occupied." Coopers & Lybrand's examination of the landlord's support for real estate tax escalations revealed that an inadequate gross-up adjustment was being made to base-year taxes. The firm researched comparables and adjusted base year taxes and eventually negotiated a settlement resulting in over $500,000 in savings to the client.
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Title Annotation:Coopers and Lybrand's Real Estate Advisory Services report on U.S. companies going to outside sources for review and analysis of operating expenses and real estate taxes
Publication:Real Estate Weekly
Date:Jul 21, 1993
Words:778
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