Lease Audits: Benefits of Outsourcing

By David Tevlin

Tight market conditions are permitting commercial landlords to raise rental rates to record levels. From tenants' point of view, it is vital that they utilize all opportunities to keep overall facility costs as reasonable as possible. The best hope for tenants in this regard is to periodically audit their leases to assure that lease provisions are being correctly adhered to and billings are free from overcharges or errors. Lease audits, by which qualified experts verify the accuracy of operating expense pass-throughs, real estate tax contributions, and any other charges other than basic rent, have become a service increasingly performed by outside vendors rather than in-house.

Within the past decade, lease audits have grown from a very small niche market with few participants nationwide into a segmented industry with several large national participants and dozens of small local firms specializing in their particular market region. The rapid growth of lease audits has been due both to the cost-cutting measures of many corporations in the face of difficult market conditions as well as by the realization by many office tenants that expenses and pass-throughs were not being properly billed. And every audit that produced savings for the tenant brought new business to the lease audit specialist.

When lease audits first began to be performed by outside professionals, the exercise often proved to be not much more than a standard due diligence procedure. Professionals who functioned as general auditors lacked the specific knowledge of real estate and familiarity with tenant/landlord case law to successfully realize savings from audits. Still, this represented an important step forward from the practice of performing lease audits by staff members of a firm who usually lacked the training, resources and time to adequately address the challenge of analyzing complex lease provisions and oblique billing practices of landlords.

The advantages of outsourcing lease audits rather than doing them in-house are easily recognized when certain considerations are made clear with respect to the audit process. First of all, most lease audit firms perform their services on a contingency basis, thereby absorbing all of the financial and time-related risks involved in an audit. By one estimate, the average field audit encompassing the initial review through the final report submitted to the tenant after an inspection of the landlord's books and records can take between 50 and 60 hours. The estimate does not include additional time spent negotiating with the landlord to actually realize the savings-this often being the most time-consuming part of the process.

Lease audit professionals, with their extensive knowledge of lease clauses and market practices, are in a position to identify lease audit candidates that have a high probability of a substantial recovery. This permits them to avoid spending their resources in auditing properties with a low probability of recovery. As a result, even when a lease audit professional declines to take on a particular tenant, the tenant has learned that it may not be worthwhile spending its own resources in seeking errors in the lease.

A further advantage in having outside professionals perform a lease audit is that a second and independent set of eyes review the lease and billing invoices of the landlord. Too often, in-house lease administrators are so familiar with the files they deal with daily that they pass over indications of possible errors. It is for this same reason that many lease audit firms have a second auditor review a file for overlooked or unidentified opportunities for savings. In addition, most lease auditors specialize in certain areas such as accounting, law, electrical and other utility services, and architectural and engineering subjects. A lease audit firm is able to draw upon various individuals who have the necessary knowledge in each subject.

A consideration to be borne in mind by a tenant when deciding whether to use in-house auditors or engage outside professionals relates to the relationship the tenant wishes to have with its landlord. Some tenants are concerned that engaging an outside firm to conduct an audit will result in a confrontational relationship with the landlord. Although this can occur, most landlords accept the right of a tenant to examine the landlord's records relating to rent and other charges. It is more likely that the landlord would prefer to deal with an outside auditor who will conduct a review efficiently and in a minimum of time. Even in situations when the magnitude of the claim creates a level of acrimony between the auditor and the landlord, prudent tenants that have utilized outside professionals are able to insulate themselves from any unpleasantness, and indeed may be in a position to step in and help to negotiate a satisfactory settlement.

A final consideration with respect to maintaining a relationship with the landlord arises when the tenant and the landlord have a contractual or other relationship separate and apart from the landlord/tenant relationship. While this can be a very sensitive concern to the tenant, he should bear in mind that rent and lease escalations are second only to payroll for most corporate tenants and should be reviewed just as is any other invoice sent by a vendor.

David Tevlin is Managing Director of Corporate Real Estate Services in BDO Seidman's New York office. He can be reached at (212) 885-8378.

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