3 Things Every Tenant Should Be Aware of in Expense Reconciliations

Generally, commercial landlords send out operating expense (OPEX) reconciliation statements for the prior year 90 to 120 days after the end of the calendar year. Many tenants receive a bill that does not provide sufficient explanation of the total amount billed or provide supporting documentation.

Typically, most commercial landlords assume that tenants won’t check expenses they are asked to pay as part of the lease arrangement. It is common for tenants to overpay their share of expenses. Most overcharges happen because of honest mistakes, new software used for calculations, or an overzealous professional trying to increase the profitability of the property for their client.

It is important that the tenant understands their fair share of expenses. Here are three things tenants need to be aware of when performing an operating expense reconciliation:

1. Compare Statement with Base Year OPEX

The typical commercial lease agreement utilizes a “base year” for operating expenses related to running the building. The operating costs for all subsequent audits must be compared with the original base year costs.

If new items are added at some point during the tenancy, you must make the necessary adjustments:

Adjust the base year to account for the new item as if it existed in the original period.
Do not include the cost in current years.
Don’t expect the landlord to hand over the base year information voluntarily. Commercial tenants should make it their responsibility to obtain this critical information and file it away for use for future expense reconciliations.

2. Examine the “Gross Up”

A balanced gross up provision in the lease works in the favor of both the landlord and tenant. Gross up refers to the practice that allows landlords to overstate or pass on certain “phantom expenses” to the tenant. This provision addresses distortions in operating expenses when a property has less than 95% to 100% occupancy for the calendar year.

If the property is only partially occupied, the landlord has the right to increase each tenant’s proportionate share of the building’s operating expenses that vary with occupancy. Conversely, if the property is fully occupied as defined under the provision, the gross up provision should not be triggered.

Here is an example of a simple gross up provision contained in a commercial office lease:

“If the building is less than 95% occupied during a portion or all of the calendar year during the term, including the base year, the Landlord will make an adjustment to the operating expenses that fluctuate with occupancy for such year to reflect 95% occupancy of the building during such calendar year.”

3. Time Limit for Notification of Errors

It’s critical to conduct the review of the annual operating expense reconciliation statement promptly. The operating expense reconciliation process can take weeks or even months. From the moment the tenant receives the statement from the landlord, the clock on the time limit in which the tenant must notify the landlord of any errors starts ticking.

If the tenant fails to raise any issues by the designated deadline and request a correction, the expense items, as outlined in the statement are automatically deemed conclusive. This means that regardless of how outrageous and obvious the questionable expenses are, they become a binding obligation to the tenant.

Other Tips for Conducting Operating Expenses Review

Focus on the accuracy of the accounting and whether the landlord abides by the negotiated lease language and provisions. Conduct the review and handle any discrepancies in a manner that maintains good relations with the landlord.

Consider hiring a professional tenant rep. Many commercial leases and reconciliation statements can be rather complex.