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Welcome LawSeminars
International“Audits of Operating
Expenses and RealEstate Taxes:Language and
Reality”
Introduction to the Panel
Terry Barger, Managing Member
CyberLease, LLC
*********
Marc Betesh, President
KBA Lease Services
CyberLease, LLCand
KBA Lease ServicesLease audit services for tenants for the past 20
years
Unique Perspective
• Part Landlord / Property Manager• Part Broker• Part Attorney• Part Accountant• Part Arm-chair Quarterback
Landlord’s thought process
Complexity of Operating Expenses
Today’s Agenda
Explore 2 specific issues – GAAP andAudit Rights
Show problematic lease language fromactual leases
Discuss how to negotiate better language
Questions and answers
GAAPWhat is GAAP?
• Generally Accepted Accounting Principles A series of books which one can obtain clarification Standardizes treatment of financial statements Bolsters reliability of statements
• What does it require? Matching (expenses to revenue)
(cost to time period incurred) Accruals (12 months in each year) Definition of capital expenditures and the treatment
thereof
Where is GAAP applicable?
• Financial statements• Real estate leases
GAAP - Lease Applicability
• Management Fee Requires uneven rent streams to be straight-lined (FASB
13) for financial statement purposes. If rent partially or fully abated in base year,
management fee would be artificially low.
• Annualization / Equivalency – Protects against base year having 10 months of
expense, and other years having 13 months of expense.
• Capital Expenditures• Applying expenses to the year it was incurred –
Real Estate Taxes in particular• Isolates P&L’s for Special Cost Centers
HVAC and Garage expenses
GAAPOther Benefits
Basic Protections
• No duplication of costs or revenues
• Mathematical / proceduralsoundness
• Provide clarification for “fuzzy”description of capital contained inmost leases
in accordance with generally accepted accountingprinciples
consistently applied
GAAPCorrect Language
GAAP or No GAAP Negotiating the Best
Language REITS and pensions funds already required to
maintain financials pursuant to GAAP
If landlord not a REIT or pension fund, usecompetitive buildings as basis for “market”
GAAP provides the parties with an impartialauthority – helps eliminate/resolve disputes
Provides tenant with most basic protections –landlord refusal makes its intentions appearsuspect
GAAP – Case StudiesManagement Fee
• 350,000 RSF Building – base year structure – Tenant 40%• Tenant received 12 months free rent during Base Year• Big 4 “blessed” books• Increased Management Fee $.55/rsf to accommodate Free Rent or $77,000
worth of savings per year
Annualization of Expenses
• 11 months of utility and janitorial expense in base year(1 month missing = $145,000 artificial understatementof base year expenses)
• 12 months of utility and janitorial expense in later years (normal)• $58,000 of savings per year
Total Savings on these two issues: $135,000 immediate, $1.2M over term
Capital Expenditures
• $120,000 costs for “repairing” HVAC system. We claimed capital, landlordclaimed repair. Went to arbitration and our client got back entire amount
GAAP – Case Studies (cont.)Match Expense to the year it was incurred
• Tenant had 2004 base year• Landlord gets $500,000 supplemental tax bill associated with
2004, but charges it to 2005 comparison year• Tenant was 30%, saved them $150,000/year for 9 years by
putting expense into year actually incurred
Matching Expenses to Revenues
• Tenant is 100% of building and paying all costs includingelectricity and hvac r&m
• Landlord has been billing them $10.00/hour/floor• Landlord had not been offsetting the income it received to the
expenses. Saved client over $300,000 from past overchargesand reduced costs to $.80/hour for accelerateddepreciation
one hundred eighty (180) days
an independent certified public accountant
not paid on a contingency
Tenant, thereafter, waives the right or ability to dispute
deemed to be Tenant'sapproval
certified public accountant selected byLandlord
Audit RightsTypical Language
Audit Rights
Why Does a Tenant Need Them?Need to understand landlord’sthought process
Source of Rights
• Specifically Granted by the Lease
• Specifically Granted by Law
Blue: Explicitly Recognized
Red: Uncommitted on Issue
Audit Rights – Good FaithStates that Recognize Implied Covenant of Good
Faith & Fair Dealing as Applicable to Leases
Audit Rights – TimeRestrictions
Shortened Time Limits
• Notice of objection to bill
• Time to complete audit
• Deadline for commencement ofproceedings if no agreement
• Landlords will “slow play” audit
Audit Rights – FirmRestrictions
Who Can Do the Audit
• Type of firm CPA firm / Big-4 CPA firm SOX issues – attestation vs. consulting
• Compensation structure Flat / Hourly Fees somtimes cost-prohibitive Fallacy about impact on audits
• Contingency fees actually expedite audits• Hourly / flat fees often prolong audits
• If Tenant can audit for itself, isn’t thatthe same as a 100% Contingent Fee?
Tenant or its representative
at least fifteen (15) years experience
Tenant's Prorata Share of Direct Costs
pay Tenant interest
reimburse Tenant for Tenant's reasonable out-of-pocket expenses
Audit RightsCorrect Language
Audit Rights -Negotiating Language
Remind Landlord audit right already granted by GoodFaith & Fair Dealing. Why do anything less if you donot get any value for it?
Not waiving other Statues of Limitations in Lease, whywaive on this – unless get great value for doing so?
Landlord has the same time frame to issuereconciliations as tenant has to audit them.
Would landlord prefer 4 audits in 4 years, or one auditin 4 years? Reasonable fallback positions on timing
Can audit the base year at least one time
Audit Rights – Who CanPerform
Tenant should be able to use own personnelto audit.
Certified Public Accountant Individual okay, if that gives the landlord some
comfort level
Firm – NO!
Qualifications to Satisfy Landlord At least 15 years experience of real estate
accounting experience.
Audit RightsOther Issues
Reimbursement of Audit Fees
• Error test on “Tenant’s Pro rata Share,” notbuilding level.
• Know what Flat Fees can be … don’t capreimbursement.
• Landlord’s concern about Contingency vs. Flat Feereimbursement
Interest
No completion deadlines
No need to reimburse Landlord’s “costs”
Audit RightsCase Studies
Tenant missed 60 day audit window and final & binding
• Landlord used wrong base year• Statement was “final & binding” / deemed approved.• Landlord claimed tenant waived its right• Landlord’s error cost the tenant $75,000 that year.
Landlord enforced “Big 5” CPA provision
• Landlord just prevented the audit – Theory of Impossibilities• Are you going to sue to get access?• Potential cost to tenant was $50,000 per year with 4 years remaining on
lease.
Whose responsibility to have the books and record for the building?
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