Commercial Property Owners and Managers Are Pressed for Time
Budgeting. Accounting. Reporting. Marketing, leasing and supporting tenants. Maintaining the building and physical plant. Responding to the unexpected crises that inevitably arise.
Commercial real estate owners, property managers and their leasing teams juggle a nearly overwhelming number of tasks and responsibilities, each of which always seems to be top priority. For them, there are never enough hours in the day, so occasionally, an error, mistake or inconsistency in a tenant lease will slip through the cracks.
Some Commercial Real Estate Lease Errors Are More Costly Than Others
However, some commercial real estate lease errors and inconsistencies are much worse than others and they can prove to be quite costly, from a financial standpoint and because rectifying them can be very time-consuming and chew up valuable resources. For pressed commercial real estate landlords and their busy teams, managing the fallout from damaging, easily avoidable mistakes in tenant leases is the very last thing they need to contend with.
Experts In Commercial Real Estate Leases
In the course of their work, Realogic’s expert commercial real estate lease administration and due diligence teams review, abstract and manage the administration of thousands of leases for every type of commercial real estate asset every year and inevitably we see certain errors, mistakes and inconsistencies in those leases over and over.
Whenever we do come across an issue or potential issue in a lease, we of course alert our client to help protect them financially and operationally, because accuracy is so critical to good commercial real estate lease administration and because we always strive to go the extra mile for our consulting clients.
11 Costly Errors and Issues We Often See in Commercial Real Estate Leases
To help everyone who owns or manages commercial properties avoid these common but potentially costly and time-consuming mistakes in commercial real estate leases, some members of our skilled and experienced lease administration and due diligence teams shared some issues in commercial real estate leases they see regularly and the potential consequences, then some tips and best practices for avoiding them in the future and fixing them if they are in any of your tenant leases now to head off any potential problems ahead.
Lease Issue 1: Real Estate Taxes Included Under Common Area Costs
“We recently abstracted a lease for a large retail tenant where real estate taxes were a separate expense from common area costs. There were separate provisions for each, separate timing for payments and different language on pro rata share of taxes. However, real estate taxes were also included within the definition of common area costs. Also, there was a specific amount cap on common area costs for Year 1 and a cap on percentage increases thereafter.”
Potential Consequences:
“The tenant could argue that real estate taxes are included under the common area cost cap and ask for a cap on taxes, which would force the landlord to cover any underpayment, cutting deep into the building’s cash flow every year. It could also result in a legal dispute between the landlord and tenant, which could get expensive due to attorney’s fees and require a lot of time and work on the part of the property manager and their team.”
Charri Issacson, Senior Manager
Lease Issue 2: Pro Rata Share Incorrectly Stated
“In one instance, I discovered that in almost all the tenant leases for a building, the Pro Rata Share was incorrectly stated. For example, in one lease I reviewed and abstracted, Pro Rata Share was stated as .362%. However, based on the defined mechanics of Pro Rata Share, it actually calculated at and should have been 3.62%. There’s a huge difference between .362% and 3.62% of expenses, obviously. If the operating expenses for the building were $1,000,000, using the stated 0.362%, Tenant reimbursed Landlord $3,620.00, when in fact Tenant should have reimbursed $36,200, resulting in the landlord being under-reimbursed by $32,580– and that was just for one tenant.”
Potential Consequences:
“It was probably a simple case of someone not being careful and putting the decimal point in the wrong place, but that seemingly tiny mistake could result in the tenant paying much less than their fair share of recoveries and the landlord would have to cover the difference, which could be very costly. In commercial real estate, every penny counts.”
Michaela Torrez, Manager, Lease Administration
Lease Issue 3: Months Not Clearly Defined
“One issue I see in leases is the rent schedule is based on months, but the term ‘months’ is not clearly defined. Is it calendar month? The anniversary of the commencement date? That can create a lot of confusion.”
Potential Consequences:
“First, it can create confusion on everyone’s part. Second, it can lead to disagreements and friction between the tenant and landlord about what’s due when and what’s supposed to happen when. Second, it can create delays in rent and recovery increases and collections, which can affect a property’s cash flow and balance sheet as well as result in accounting errors, which take time and work to correct and impact financial reporting for the building.”
Christine Carroll, Manager, Lease Administration
Lease Error 4: Verifiable Dates vs Hard Dates
“There are three errors in commercial real estate leases I see a lot. The first is while the commencement date or additional premises commencement date requires verification, the rent schedule is presented with hard dates. For example, the commencement date might be defined as ‘the later of 7/1/25 and the date the landlord delivers the premises to tenant with the landlord’s work substantially complete’, yet the rent schedule is presented with hard dates—7/1/25- 6/30/26, 7/1/26- 6/30/27– and so on– instead of ‘Lease Month 1-12 or Lease Year 1’, requiring us to make assumptions.”
Potential Consequences:
“This could lead to accounting errors, which would affect financial reporting and require time and work to correct. Also, the property manager, who’s already pressed for time, would need to confirm the intent of the lease language, which can be time-consuming. It can also frustrate and annoy a good tenant because the dates are mismatched or unclear so they must make assumptions about how much rent to pay and when or other critical details that should be clear.”
Lease Error 5: Gaps In Dates – Rent
“The second mistake I often see is gaps in dates due to the wrong language being used, especially for rent schedules. For instance, the Base Rent schedule might read ‘Second anniversary of the commencement date to day immediately preceding Expiration Date: dollar per square foot’ when it should read ‘…to the Expiration Date’”.
Potential Consequences:
“Besides the potential for accounting errors and creating extra work for the property manager, the tenant could argue they don’t owe rent for the day or period in question, resulting in a loss of rent, which could be very costly for a large tenant.”
Lease Error 6: Gaps In Dates – Abatement
“Similar to my second issue, I come across potentially costly mistakes in abatement clauses all the time. One recent example: the abatement clause in a lease read in part, ‘…shall be abated in full for the 12-month period commencing on the commencement date and ending on the 12th month anniversary of the commencement date.’ The way the abatement period is expressed, the tenant is entitled to 12 months and one day of abatement, in this case of Net Rent and their Pro Rata Share of taxes and operating expenses, when the landlord intended to give them only 12 months.”
Potential Consequences:
“As with the previous example, every penny counts to a building owner, even if it’s just one day’s worth of rent. If the landlord resisted and the tenant persisted, the matter could end up in court, adding to the landlord’s expenses. Also, confusion over the length of the abatement period could result in accounting and reporting errors, as other dates may be reliant upon the end of the abatement period.”
Donna Chilia, Manager, Lease Administration
Lease Issue 7: Amount of Space Being Leased Is Inconsistent
“I also have three errors and inconsistencies I see in leases to share. First, oftentimes, the amount of space being leased is stated inconsistently throughout the lease. For example, in a lease I recently abstracted, the Amendment Recitals stated that the tenant was leasing a total of 3,277 square feet. However, a different section of the same amendment, which happened to address Pro Rata Share of expenses, stated that the tenant was leasing a total of 3,160 square feet, 160 rsf less.”
Potential Consequences:
“The biggest consequence would be in terms of Pro Rata Share of tax and operating expenses. In my example, the obvious consequence was that the tenant would be paying less than their fair share of the building’s expenses and the landlord would have to absorb the difference. It was a 10-year lease, so that difference would really add up over the full term of the lease. Inconsistently stating the amount of space being leased could have other negative consequences too, including on monthly rent, depending on where in the lease the figure is misstated.”
Lease Issue 8: Inconsistencies In Rent Escalation
“There’s a theme here: inconsistencies! A second inconsistency in leases I see a lot is in the escalation of rent. One section of the lease might state that rent will increase 3%, but another might state 1% and another might state 0%. These are probably just oversights on the part of whoever drafted and reviewed the lease, but they should be caught before the lease is executed to head off any problems before they occur.”
Potential Consequences:
“The most worrisome consequence is that, depending on where in the lease the escalation is misstated, the landlord might not be able to increase the tenant’s rent or increase it as much as intended and that would impact the property’s cash-flow and profitability over the long-term. If the landlord wants to contest that, they’ll probably need to involve a lawyer, adding additional fees.”
Lease Error 9: Lease Year, Calendar Year Used Interchangeably
“My third issue is that Lease Year and calendar year are often used interchangeably. Sometimes they correspond. Oftentimes they do not. When drafting and reviewing leases, it’s important to check if the two dates are the same or different and, if different, which date to use where, based upon the intent.”
Potential Consequences:
“Mixing up calendar and Lease Year can have all sorts of harmful consequences, depending on where in the lease the date is used. For instance, if the wrong date is stated in the clauses on rent escalations, abatements, taxes, operational expenses or other sections of the lease that dictate cash flow or expenses, it could potentially causing a dispute.”
Sean Flood, Vice President, Due Diligence Abstracting
Lease Issue 10: Vague Operating Expenses
“I often find myself talking to clients to confirm what’s included under operating expenses and what’s not. For example, management fees. Is a percentage management fee chargeable to the tenant and, if so, how is the amount calculated? Or, capital improvements or expenses. Many clients want to know if those can be included in operating expenses and in what situations.”
Potential Consequences:
“Obviously, if the lease explicitly states which expenses are categorized as operating expenses, there’s little or no question that the tenant must pay for them. If operating expenses are not specified in the lease, it can inhibit the landlord’s ability to collect for certain expenses, especially those that a tenant might question, like management fees. If a tenant successfully disputes a certain expense, then the landlord has to cover the cost themself, which reduces the building’s profits.”
Olia Olijnyk, Manager, Due Diligence
Lease Issue 11: ROFO and ROFR Used Interchangeably
“I see it in leases all the time: the terms ‘ROFO’ and ‘ROFR’ are used interchangeably. It’s like the misuse of ‘there’, ‘they’re’ and ‘their’. They are not the same thing and there are important differences and implications, which we explain in this blog post.”
Potential Consequences:
“Not only can this common mistake cause confusion for both the landlord and tenant, but it can lead to even bigger problems, such as the landlord failing to approach a tenant with ROFO rights about the space before offering it to other prospective tenants. If the tenant with ROFO rights really wanted the space, they could press the matter and the landlord might have to make some sort of financial restitution or the tenant could take the landlord to court, which would be expensive and time consuming and would harm the landlord’s reputation.”
Avoiding Costly Errors in Your Commercial Real Estate Leases
The best way to avoid costly errors and mistakes in your commercial real estate leases is simple and obvious but labor-intensive and time-consuming: before any lease is executed, make sure it is reviewed thoroughly and by multiple people because, as the saying goes, four eyes—or six or eight or 10—is better than two.
- Create A Checklist For Lease Reviews: Create a checklist of people in your organization who are knowledgeable about and experienced with commercial real estate leases and have everyone on your list review every lease from beginning to end. Someone representing building ownership should review the lease as well as the property manager and someone from the team that administers the building’s leases.
- If you outsource all or part of your lease administration to a third party, add someone from that group to your checklist as well. Look not only for the errors and inconsistencies our team shared in this post, but also any others—even typos.
- Don’t Take Short Cuts: For busy property managers and their teams, who are already pressed for time, it might be tempting to skip reviewing leases, only review the occasional lease, take shortcuts—only review certain sections—or just wing it and hope for the best. But thoroughly reviewing every lease before it’s executed could save you from all the costly and time-stealing problems and headaches our team discussed above or maybe even worse.
- Give Attorneys Full Access to Your Commercial Real Estate Documents: To help avoid mistakes and inconsistencies in your tenant leases in the future, make sure the attorneys who draft your leases are aware of and have access to all your lease documents, including amendments. Oftentimes, external or even in-house attorneys are unaware of the existence of some amendments or letter agreements so any changes to the original lease are not incorporated into subsequent versions, perpetuating any issues. This is more common in buildings that turn over frequently.
- Implement A Good File Management System: All paperwork should be in good order, properly marked and readily available to your attorneys and to you and the members of your lease administration team. It helps to have a good file management system– not just for your leases but to organize and track all your correspondence and paperwork– and to give your attorneys access to any leases and relevant documents so they don’t miss any important updates or changes the next time they draft a lease.
- Also, as a backup, be sure to email new leases, lease amendments and letter agreements to building ownership, your attorneys and everyone on your lease administration and property management teams, including your property accountant.
Rectifying Issues and Errors in Commercial Real Estate Leases
- No process is foolproof and people who work in commercial real estate are busy, so even if you’re meticulous about reviewing your leases and sharing information and documents, you or a tenant are bound to discover a notable error, issue or inconsistency in one of your leases at some point. Or, the issue might have been lurking in the lease long before you updated your policies and processes for drafting and reviewing leases.
Regardless, when someone does come across an issue in one of your tenant leases, the two best ways to rectify it are with a lease amendment or a bi-lateral Letter Agreement.
- Commercial Real Estate Lease Amendments: A lease amendment is a legal document that is an update to a lease. Lease amendments are generally drafted by attorneys. The upside of using a lease amendment is they can amend any number of items in the prior documents. The downside is the expense: you’ll incur legal fees, which will cut into your operating budget. Also, because there are generally multiple parties involved in drafting, reviewing, revising and executing lease amendments, they can take a long time to execute.
- Bi-Lateral Letter Agreements: The second way to update or correct an error or inconsistency in a tenant lease is with a bi-lateral Letter Agreement. Letter Agreements are similar to lease amendments in that they’re documents that update clauses, wording, numbers or other details in a tenant lease. However, a Letter Agreement usually covers only one or two minor issues. Often, they are drafted by the property instead of an attorney, which saves time and money.
Which Is Best, Commercial Real Estate Lease Amendments or Bi-Lateral Letter Agreements?
The short answer is it depends on a company’s structure and policies. Every organization has different priorities, budgets, processes and people. So, what’s best for one company might not be best for another.
Generally, lease amendments provide the most protection to landlords, but they’re more expensive and take longer to draft and execute. Letter Agreements are quicker and easier to draft and execute and they’re the less expensive option because they don’t require the help of an attorney, but drafting without legal oversight could lead to additional issues.
So, it all depends on your organization, what you prioritize and what people and resources are available to you. Either way, correcting errors and inconsistencies in your tenant leases when they’re discovered and clarifying intent is much wiser than ignoring the issue and deferring the outcome to a later date.
More On Commercial Real Estate Lease Administration
We hope this post and the insights, tips and information we shared on spotting, avoiding and rectifying costly errors in commercial real estate leases enable you and your team to run your commercial properties more smoothly, efficiently and profitably.
If you’d like more helpful tips and best practices for commercial real estate lease management, we can point you to several resources.
Commercial Real Estate Lease Administration Best Practices
First, there’s our blog series on commercial real estate lease administration best practices. There are three chapters in the series:
- Chapter three is on letters of credit and storage space. Those might seem like minor concerns but as we’ve found, they can have an outsized impact on a property’s profitability.
Lease Administration for Troubled Commercial Real Estate Assets
Second, there’s our post on lease administration for troubled commercial real estate assets, a very timely topic given the current state of the office sector and the growing number of distressed office assets.
Helpful Resources on Commercial Real Estate Lease Administration
Then, there are a number of resources on lease administration in our library, including:
Expert Lease Administration Services for Commercial Real Estate
For more information on our commercial real estate lease administration services, including lease abstraction and our rAbstract, Yardi, MRI and JDE services, visit the lease administration page on our website or contact us at 312-782-7325 or info@realogicinc.com