(Tenants are you taking notice?)
In Part 1 of this series, published in the previous post, there was discussion on how landlords can maximise their revenues by getting more money out of their tenants taking advantage of the many complex clauses in lease agreements, particularly those related to the outgoing recoveries.
In this previous article, clauses related to outgoings definitions, audited outgoing statements, management fees, marketing and leasing costs, and cost of a structural and capital nature were explored. This article continues this outgoings discussion but also broadens the scope into other ways that landlords can extract additional revenues from their tenants.
With most commercial assets in major cities, landlords will own the physical buildings and the site on which it has been built outright. However, in some instances the ownership only relates to the structure itself without full ownership of the site, with tenure controlled via ground leases or access licences. In these cases, it is likely that regular ground rents, levies or licence fees are payable.
Such costs should be classed as part of the cost of ownership and in principle should not be recovered via an outgoing charge. The rationale is simple, the landlord securing tenure by acquiring a long leasehold right over the land to develop a building, will have invested less in the property than the landlord who has purchased the full freehold title of the site. But many tenants will not understand the difference between these tenures and believe that land rent is legitimately part of the outgoings, seldom disputing these costs.
Similarly, many commercial property investments are geared with some level of debt finance. With this finance structure, it is likely that regular interest and possibly even principle payments are due. Such costs should also be classed as part of the cost of ownership, and therefore should not be recovered via an outgoing charge.
Although most tenants will be astute enough to know that finance interest should not be part of the outgoings recovered. These financing costs are not always that transparent. There is nothing preventing a landlord having an entire new air conditioning system installed based on a full service, maintenance and finance model. The monthly packaged air-conditioning costs payable related to this installation, is usually very difficult to segregate and to identify the financing component from the servicing and maintenance parts of the packaged charges, so the whole charge can be relatively easily recovered via outgoings.
Strata Office Suites
With premises leased by a tenant that are a commercial strata unit, allocations of body corporate strata levies and other costs directly to the tenant is usually often not well understood. The strata levies will likely include some sinking fund elements, retained to rectify building issues that may be structural or capital in nature. These should not be recovered from the tenant, but these are simple costs passed on via the outgoings as part of the other components of the strata levies.
Council Rates are usually direct assessments linked to Strata Ownership, and are usually recoverable from a tenant even in a Gross Rental lease structure. Land Tax is arguably an impost on the wealth of the owner but in some leases, there are provisions whereby these costs are direct recoveries from the tenants.
Out-of-hours Air Conditioning
It is usual for costs of air-conditioning operating during normal business hours to be recovered, via the outgoings, in net rent lease structures. However, if a tenant needs to use the air conditioning in the evenings or over the weekends, it has become an industry norm for out-of-hours air conditioning charges to be imposed on the tenant – usually on a floor or part-floor basis, often in the order of $50 per hour per zone. In theory, this cost is imposed as a user pays charge, to reimburse the landlord for the additional electrical and maintenance as well as accelerated depreciation on the equipment, without detriment to other tenants in the building.
Sounds reasonable. However, as most in the industry know, very few buildings are equipped with the ability to separate out the utilities and additional maintenance cost between the business hours and out-of-hours usage. Therefore, the full cost of the air conditioning operations is recovered, including out-of-hours usage via the outgoing recoveries from all tenancies. The out-of-hours costs recovered from individual tenants based on their usage, is pure profit for the landlord. This double cost recovery is seldom noted by tenants or commented on by outgoings auditors.
In some States, landlords are able to procure electricity at a negotiated discounted rate across all the buildings in their portfolio and are then able to recover the electricity used by the tenants at the regulated ‘rack rates’, thereby ensuring there is a profit margin built-in for the landlord. In situations where tenants are able to choose to procure their own electricity direct via a supplier, astute landlords will include rights within the lease agreement to invoice the tenant for a network usage charge within the building. This cost is, in theory, required to cover the use of the landlord’s building infrastructure, from the street, via the base building to the leased premises, even though the landlord does not incur any additional charges from the tenant’s supplier.
Similarly, a landlord can charge tenants for additional metering or electrical equipment costs. Although these costs can be equated to charging for the use of other building infrastructure such as the entrance foyer, lifts and toilets, tenants seldom raise this as an objection.
In older buildings that do not have the benefit of separate metering for each of the tenants in the individual office suites, or on different floor levels, the cost of electricity is usually allocated on pro rata basis, based on gross floor areas occupied. This can result in a tenant having to pay significantly higher costs than their consumption level justifies, if for example there are vacancies on the floor; if other tenants on the floor are less vigilant in conserving energy; or if there are packaged air conditioning units on the floor consuming excessive energy, particularly at peak tariff time slots.
Charges for Additional Services
There are many other devices to make money out of tenants. For example, items as simple as security cards can be used to contribute to the additional cost recoveries. It is the norm at the commencement of the lease to provide security cards based on a ratio of 1 card per 10 square metres of leased space. If ever a tenant requires more or has lost any cards there can be an additional charge, often in the order of $30 to $50 per card. These cards cost less than $1 each and are normally programmed by the site supervisor whose costs are already funded via the outgoing recoveries. And even at the end of a lease, if the full number of cards issued are not returned, there can be a similar charge.
Outgoing Increases – Double Dipping
Tenants that have signed up in a lease agreement with a gross rent structure – meaning inclusive of all outgoings – should not have outgoings recovered separately. The gross rent will likely have annual fixed or inflation-based rent reviews. This means that the outgoing portion of the rental will automatically be increased by the same percentage annually.
However, there is a neat practice that has become an industry norm – the recovery of increases in the outgoings over the base year when the lease was signed. There are many tricks that can be used to ensure this increase is manipulated to a landlord’s advantage that are seldom noted in any outgoings audit. These include aspects such as the date of the base year, the inflation index chosen, the treatment of equipment under warranty, etc.
Undoubtedly the most lucrative part of this practice is the double-dipping related to the increase, first capturing the indexed increase as part of the rent review, and then fully recovering the actual outgoing increase based on the increase recovery clause.