If you’re an executive at a company that leases commercial space, you’ve probably received a call (remove “probably” and add “constantly”) from a myriad of commercial real estate brokers who tell you that they can save you money and/or that your current broker isn’t… doesn’t… can’t… etc. Basically, they’ll say just about anything and everything to get their foot in the door. I know that all my best relationships/decisions, both professional and personal, started with a cold call (enter sarcasm). One of the most common tactics used by commercial brokers is offering to review your pass-through payments.
In full service (office) leases, all costs of ownership (operating expenses/CAM, real estate taxes, & insurance) are included in your base rental rate. The first year of your lease is called your base year. If those costs increase over the lease term the landlord will pass those expenses through to you, the tenant. For example, company A signs a lease on March 1, 2019 for 5 years with a base rental rate of $25 per square foot. The costs of ownership in that year are estimated to be $10 per square foot ($15 per square foot profit to the landlord). In year 2 the costs of ownership increased to $10.25 per square foot. Therefore, the landlord would charge the tenant an extra $0.25 per square foot in addition to the annual rental escalation.
What these cold-calling brokers are offering to do is essentially audit the landlord’s books to see if they overstated the costs of ownership and have overcharged you.
I’m not saying that landlords don’t make mistakes, but I would say it’s uncommon. Landlords have an interest in keeping the costs of ownership low. Sure, they can pass through the charges to tenants if they increase but this makes them less competitive and attractive in the marketplace. If Landlord A has costs of ownership of $10 per square foot and Landlord B is at $8 per square foot, Landlord B can offer an asking rate of $25 for a profit of $17 per square foot while Landlord A will have to charge $27 per square foot for the same return. All things being equal, which building would you choose? In addition, if one landlord has costs of ownership that increase year after year, their tenants would be less inclined to renew; choosing to relocate to a building in which their costs of occupancy are lower and/or more stable.
The idea that a landlord would intentionally overstate expenses and overcharge tenants is even less likely. There are certainly unscrupulous players out there, but they’re quickly exposed. Landlords don’t want the reputation of being charlatans.
If the landlord does mistakenly or intentionally overstate the costs of ownership, the amount is most likely negligible (on a per square foot basis). The exposure increases directly based on the amount of square feet you occupy ($0.25 per square foot is only $250 at 1,000 SF vs. $25,000 at 100,000 SF). That’s not to say that you shouldn’t do everything you can to save money. You shouldn’t pay a penny more than you owe and if your pass-throughs increase, it’s not unreasonable to request a copy of the landlord’s books to inspect them. I’m a firm believer in the principle of the matter but one needs to perform a cost benefit analysis. Would you spend $500 to save $250 or even $500?
So, are these brokers really flying in to save the day? No. They’re really just trying to get their foot in the door and are likely more interested in making themselves money than saving you money.
This is all a moot point if you/your broker did not negotiate an audit right provision in your lease. For more information on audit rights, check out my article Lease Audit Rights or contact me at Ryan@RealMarkets.com.