Written by: Jim Brogan, Lease Integrity Group
Companies are planning for re-entry and working with building management to understand the upgrades and changes needed to ensure the safety of the workplace and the health of their people. What happens next may not be noticeable until 2021, but there will be financial ripple effects on your liabilities due to the unorthodox occupancy trends caused by COVID-19.
Luckily, here at Limestone we have a pretty clear understanding of the correlation between changes to an asset/use of a building and the resulting operating expenses. We are pleased to present our predictions in chronological order:
WHAT’S HAPPENING NOW?
As many buildings remain fully or partially shut down, the building operating expenses/common area maintenance (“CAM”) expenses will generally be lower than normal due to the limited use of the buildings and its facilities, as well as the reduced services provided to the individual tenants. Because most tenants pay a monthly, estimated amount for 2020 CAM (a figure that was determined in 2019), there is a good chance the 2020 actual expenses are less than the estimates being paid. Accordingly, you may want to request that your exposure to the estimated CAM charges be reduced during this period.
In early 2021, landlords will reconcile the 2020 estimated CAM costs with the actual spend in 2020, and we suspect there will be a plethora of problems with required expense “gross-ups” (occupancy adjustments), as these will be particularly difficult for the landlord to determine during this period.
WHAT WILL HAPPEN BETWEEN BUILDING RE-OPEN THROUGH WIDESPREAD VACCINE AVAILABILITY?
It should be no surprise that costs for base-building janitorial services will increase as continuous daily disinfecting will be necessary in all public areas. We suspect the same increases will occur for base-building security services due to enforcement of state-mandated and/or building regulations regarding social distancing and capacity limitations.
Similarly, costs may increase due to temporary installations to aid in controlling the social distancing regulations and capacity limitations, and perhaps even due to the increased use of the elevators as capacity is reduced and more trips become necessary.
Some of the improvements and installations landlords consider in response to COVID-19 may be of a permanent nature, such as enhanced security desks and systems, touchless modifications to door/elevator systems and HVAC filtration systems. Depending on the provisions specific to each lease, tenants may be responsible for these costs in the year they are incurred, or perhaps the annual amortization expense over the useful life of such new installations/improvements.
SO WHERE’S THE CONFUSION?
The occupancy and use variations, along with temporary and permanent improvements spurred by COVID-19 may cause widespread confusion around the determination of tenants’ liabilities for CAM Charges.
Landlords will seek to pass though most, if not all, of the additional costs incurred to address COVID19 issues. Check your lease for expense cap limits as they may offer at least partial protection from these increases, but note that landlords will likely argue that no limitation should be applied as the cost increases are out of their control.
Expense gross-ups may result in distorted expense levels. It is important to have an expert evaluate this treatment carefully because, depending on the type of lease and the CAM liability calculation methodology, the gross-up could overstate or understate a tenant’s liability.
Be hyper-vigilant if you have a modified-gross lease with a base year of 2020 or 2021. The Base Year expenses from these years will need to be closely scrutinized by an experienced lease audit firm with legal, forensic accounting and building ops experts to ensure the expense level is a fair representation of the costs necessary to operate the building for the remainder of the lease term.
Charges for long-term capital installations/improvements to address the current COVID-19 pandemic, or perhaps other future pandemics, will need to be evaluated based on the specific provisions in each lease, to determine the extent to which a tenant may be responsible for such charges.
Although a lease is intended to create a somewhat static and predictable relationship, situations like COVID-19 show us how fluid the occupancy lifecycle can be. There are countless unforeseen issues/circumstances that the landlord/tenant did not, and could not, contemplate when the lease was executed. Therefore, it is critical to evaluate the financial effects of COVID-19 in the context of the unique provisions agreed to in each lease so that the parties can reach an equitable resolution to any matters that may arise. We always recommend a conservative and well-considered approach that respects the many facets of lease language, financial treatment and building mechanics. The rigor and sophistication that is required to draft and execute the deal should be applied in equal measure to interpret and resolve any potential issues of this nature.
Of course, if you have any questions about this topic, or lease “auditing” in general, please contact Jim Brogan (LeaseIntegrity@gmail.com; 248.703.2724). We have been exclusively focused on understanding and resolving all levels of post deal economic exposure for the last 30 years, and would be happy to share our knowledge with you and continue to learn alongside you.