Last Updated on August 28, 2023 by Morgan Beard
Leasing commercial space comes with complexities that often lead to overpayments and disputes. Opaque lease terms and calculations can perplex even seasoned tenants. This is why a regular lease administration audit is so valuable, especially when your building gets a new owner. By verifying the landlord properly assumed all prior obligations and maintains accurate accounting, you avoid financial surprises and optimize your tenancy. This blog explores lease audits in depth, with tips on security deposits, allowances, expenses and more. Learn why audits are essential during ownership transitions and how to ensure a watertight process.
Lease Audit Definition
A lease administration audit is a detailed review of a company’s lease agreements and related financial records to ensure compliance, accuracy and optimization of the leasing program. It involves examining all aspects of lease administration, including rent calculations, operating expenses, tenant improvements, security deposits and more.
Audits help identify errors or overpayments, recover missing revenues, ensure proper accounting practices, and reveal opportunities to improve operational efficiency. For companies with large real estate portfolios, regular auditing is essential to control costs and maximize the return on leased assets.
A lease audit is key to accurate financial reporting thus ensuring your lease expenses and occupancy costs are not higher than they should be. An annual audit should look for cost-saving opportunities as well review lease language to ensure that your rights and obligations are being properly executed. Implementing a lease management software as your centralized database that provides internal controls over your financial inputs and outputs is important.
Why Lease Abstraction is Important?
Lease administration audits are important because even small billing errors can cost tenants or landlords considerable sums over time. When a building is sold, new owners may use different accounting practices which introduces opportunities for mistakes. Careful review ensures the transition goes smoothly and lease financials remain accurate under the new administration. Tenants benefit through potential savings and better control. Landlords gain by demonstrating professionalism, prevent revenue losses and optimize their portfolio’s performance. Regular audits encourage positive tenant relations and protect the interests of both parties when executed properly.
A security deposit is an upfront payment required by landlords to cover potential damages or unpaid rent. Tenants pay deposits when signing their lease which landlords must refund at lease end, minus any lawful deductions. Deposits offer landlords financial protection but limit tenant cash flow. State laws regulate the allowable amounts and handling processes. Tenants should ensure deposits transfer properly when their building’s ownership changes.
What happens when the building is sold
When a leased building changes ownership, tenants should pay careful attention to their security deposits. In some cases, the sale of a property can put deposits at risk if mishandled during the transition. To protect their deposit, tenants should request written confirmation from the new landlord agreeing to assume responsibility. Otherwise, the deposit could disappear into the previous owner’s accounts.
Banking and letters of credit
Leases often require security deposits in the form of letters of credit from the tenant’s bank. When a property changes hands, former landlords typically transfer these letters to the new owner. However, tenants should obtain written acknowledgement that the new building owner has received and accepted the letters as a continuation of the deposit. Otherwise, the new landlord may improperly claim the deposit was never paid.
How do you ensure your deposit is still valid?
To avoid security deposit disputes when ownership changes, tenants should take three key steps:
- Get written confirmation that the sale occurred and identify the new landlord.
- Obtain the new owner’s acknowledgement of receiving your existing deposit.
- Request documentation showing your letter of credit was transferred to the new landlord’s bank.
Following these best practices ensures a smooth transition of deposits between building owners.
Lease agreements often provide a tenant improvement (TI) allowance which tenants can use to construct, renovate or customize their rented space. If the TI allowance is not fully utilized by move-in, tenants may be entitled to remain eligible to draw from it under the lease terms. When ownership changes, tenants should obtain the new landlord’s written acceptance of any TI allowance balance to prevent losing their unused credit.
The tenant never requested money from the landlord. Have you received everything that is due to you?
Many tenants miss out on receiving their full TI allowance because they are unaware of the procedure for obtaining the funds. Landlords are only obligated to reimburse tenant improvement expenses if properly submitted for approval in advance. Therefore, it’s critical to understand the required process which is usually detailed in the lease. Don’t leave money on the table by assuming the landlord will proactively provide the allowance. Be sure to file the necessary paperwork.
How to navigate when the landlord is re-billing the tenant?
Some office leases include base year utility expenses as part of the tenant’s share of operating costs. When a property changes hands, new landlords sometimes neglect to adjust the base year when billing tenants for their utility usage. This results in tenants paying twice for the same utilities. Tenants should scrutinize operating cost statements and confirm the correct base year is being applied.
Common areas maintenance
Are you paying for your neighbors bills?
Tenants are generally responsible for their share of common area maintenance (CAM) costs. When billed incorrectly, they can end up covering expenses beyond their own leased premises. For example, by using the wrong square footage allocation formula after an ownership change. Tenants should verify the new landlord uses the correct space measurements when calculating their portion of CAM fees.
In summary, lease audits are essential when ownership changes to maintain proper lease administration. Tenants should confirm their deposits transfer and allowances roll forward to the new landlord. Also verify billing adjustments and calculations are handled correctly. With some vigilance, the transition can be seamless while protecting the stakeholder’s interests on both sides of the agreement.
5 Unique FAQs
What are some typical lease errors uncovered in audits?
Some common errors found in lease audits include incorrect calculations of base rents and escalations, improper pass-through of operating expenses, unbilled or missing payments, excessive property management fees, capital expenses billed as repairs, incorrect security deposit accounting and more.
When should tenants conduct lease audits?
Tenants should perform periodic audits throughout the term of the lease, such as every 2-3 years. Audits should also occur after any base year adjustment and when ownership of the building changes.
What documents do auditors need from landlords?
Auditors will request copies of the lease, rent rolls, operating expense details, invoices, calculations of payments, Tenant Improvement paperwork, security deposit statements and any correspondence related to the terms of the lease.
Can I recover historical overpayments if errors are uncovered?
The ability to recover past overpayments depends on the state statutes of limitations. But audits can at least identify problems and obtain corrected billings going forward.
Who should perform lease audits?
While tenants can audit internally, third-party lease auditors provide independence and specialized expertise. Look for auditors with certified designations such as the Certified Lease Auditor (CLA) for best results. Housing your lease data in a software like Lease Administration by Occupier enables your team to run internal lease audits.
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