There used to be a time, a few years ago, when most retailers paid only the most peremptory attention to lease auditing. A retailer’s accounting department would receive the bill from the landlord, go over the items to make sure there were no obvious mistakes and sign off on the check.
In fact, the lack of attention with which commercial leases often got treated after the negotiations phase ended was the main reason Marc E. Betesh, a real estate lawyer by training, decided to start a lease auditing firm in 1985. At the time, Betesh worked at the New Jersey-based offices of commercial KBA Lease Services, where he now holds the post of president and CEO.firm The Kislak Organization. His lease auditing service started as a division of Kislak and eventually became the independently owned
Today, retailers represent approximately one-third of KBA’s clients, with big-box operators and department stores serving as the firm’s main base. KBA’s specialty lies in complex transactions with many moving parts, Betesh explains, which is why it often ends up working on behalf of anchor tenants.
Of course, in the current environment, many firms are paying a lot more attention to their existing leases than they did even five or six years ago, both because they are trying to cut down unnecessary expenditures and because they are facing upcoming changes in the Financial Accounting Standards Board’s (FASB) lease accounting rules. But since retailers seldom have the necessary in-house expertise to see all the potential implications of a lease audit, Betesh feels the services of a professional auditor still come in handy. (Like many of its peers, KBA Lease Services only charges its clients if an audit results in savings.)
In addition, most of the 20 or so people who make up KBA’s staff have some background in law and can examine leases not only for accounting errors, but also for legal compliance. “We don’t represent clients as their lawyers, but we do bring that level of expertise” to the table, Betesh says. Site Optimizer spoke to Betesh about his firm’s work and the changes he sees happening in the market.
Site Optimizer: What are the most common oversights that can occur when retailers audit their own leases?
Betesh: It’s not a question of oversight. It’s a question of, “Is there another approach that’s more successful?” Let’s say you have a supermarket in a shopping center that is obligated to pay 25 percent of the costs on the Common Area Maintenance (CAM) charges. And then a movie theater moves into the center and because of that presence security in the shopping center has to be increased and the parking lot lights have to be kept on until 2:00 in the morning. The way the lease reads, the supermarket is required to pay 25 percent of these new increased costs caused entirely by the presence of the movie theater. Someone in a typical administrative function would check the bill against the lease and say, “This may be unfair, but this is what the lease requires us to pay.”
We would look at this situation and develop legal arguments over why this supermarket should not be allowed to pay for the increase. We would approach the landlord and resolve the matter. Those kinds of adjustments require a very high level of skill—you have to be able to discern nuances in the lease language and articulate your position to the landlord very clearly and very effectively. That higher level of skill is something that is often not available in the normal lease administration and CAM review function [department] within most retail companies.
SO: Can you give some more examples of the issues that a professional auditor would spot that a retailer might not?
Betesh: There is a short term versus a long term impact that various adjustments can have. For example, agreeing to the way that a cap is calculated today may yield benefits in the short term, but if you agree to the wrong trajectory of costs, it may end up costing more money over term. The interaction of the anchor store with the in-line stores can have a profound effect on how the CAM charges are distributed throughout the shopping center. Disallowing a large capital expenditure today, when the landlord agrees to spread the cost out over time, can create large savings today, but create a precedent for increased costs for every year of the lease term.
SO: How often do you feel retail leases should be audited?
Betesh: It should be done continuously, on a selective basis, throughout each portfolio. The process is to review the overall portfolio and identify all the [individual] locations, so they are reviewed on a three-year rotating basis. This ensures that every location gets a proper look and that those examinations happen at appropriate times.
SO: Have you noticed a change in how retailers approach lease auditing today versus a few years ago?
Betesh: The economy has definitely put pressure on everyone to examine these costs more carefully. From a landlords’ perspective, it’s having two impacts. First, because there is a higher level of vacancy, landlords are holding back on many of their expenditures, so the CAM costs for tenants have tended to be a little lower than normal. At the same time, landlords need to attract new tenants to their centers, so they make very selectivein their properties to attract those tenants. And those capital charges are often not allowed by the [existing] leases. But because landlords are under pressure, they are trying to recoup as much of their outlays as possible, so they are more aggressive in passing through those charges to the tenants.
And on the tenants’ side, retailers are under similar pressure to improve costs, so the tenants have stepped up their focus on functions like lease administration, CAM charges and similar items to make sure their costs are as low as possible.
One of the other trends we are seeing is that there are new changes coming because of FASB. That is putting tremendous pressure on companies to make sure they have very tight control over their leases and leasing costs so they can properly report on what they have. The changes in FASB rules are focusing a lot of attention on the leasing area that otherwise wouldn’t be there and wasn’t there before.
SO: You offer consulting services to help your clients adapt to the new FASB rules. Can you talk about what are the most pressing challenges for retailers in adapting to the new rules?
Betesh: There are two aspects of the new FASB rules that are problematic in my view. The first is inclusion of option periods in the determination of the length of a particular lease. A determination has to be made each accounting period as to whether available options are going to be exercised. I am not sure that’s appropriate. An option for real estate is only there to provide flexibility. In many cases, the options are used by the tenant in order to negotiate more favorable terms at the end of the lease. I believe it’s a mistake to include those option periods until they are exercised. A better alternative would be to give value to those options and include those values as assets on the company’s books. The way it is right now it provides opportunity for subjectivity and manipulation.
And the most problematic thing for retailers is the estimation of percentage rent over time with various projections that will have to be analyzed under each lease. Under the current proposal, a retailer must project out the probability of sales at different levels over the remaining term of the lease. It’s bad enough to have to do that for the four years remaining on your lease, but it becomes very speculative to do that for a possible option period of another five years. And it places enormous burdens on the leasing departments of major retailers, as well as their landlords, who have to go through a similar analysis.
SO: How do you help your clients prepare for these changes?
Betesh: We have a lease administration application called Visual Lease, which manages lease portfolios. In addition to that, we are assisting clients with the abstracting of all their leases, analyzing the leases to determine the appropriate split between right-of-use asset and service component, and we are helping clients to manage the overall process and interface with their outside accounting firms. We are providing a more economical way to supply all of the information needed for auditors on behalf of management.
SO: What is the pricing on your services, both on the regular lease auditing side and on FASB consulting?
Betesh: When we work on the CAM review side, we simply share in the benefits we are able to achieve with our clients. The sharing is very dependent on the scope of the portfolio and the nature of the assignment.
On the FASB work, we have our database, which is our Visual Lease software application, and that’s priced based on the size of the portfolio. And in terms of the consulting work, we are substantially less expensive than the major accounting firms in that area. We are probably 30 percent to 50 percent less expensive than many accounting firms.