It all starts with a wrist fight between lawyers and ends with an accountant with a headache. Billing commercial leases can be challenging, but with the guidelines outlined below, the process can be simplified and headaches can be avoided. Simply put,
- expense categorization,
- diligent and thorough lease interpretation,
- automatic updates
- and tailored notifications
will significantly improve the accuracy of your commercial lease revenues. Full disclosure, this is not a guide on how to write good commercial leases. I am not a lawyer. This guide focuses on effectively incorporating commercial leases into the billing cycle.
Expense categorization
In an ideal world, all commercial leases within a commercial space would use identical language, rendering expense classification unnecessary. However, in the real world, leases are negotiated at different times and by different parties, and lease standards change over time. Therefore, it is crucial to correctly categorize expenses into two primary categories: real estate taxes and common area maintenance, with the possibility of additional main categories such as insurance. These main categories should have multiple subcategories to effectively differentiate expenses among various leases and their specific requirements.
For example, a subcategory of real estate taxes could be “Tax appeals”. By correctly classifying professional services for tax appeals, it becomes easier to add or remove them from the year-end billing for each lease, according to their requirements.
Common area maintenance will have many more categories, as it covers a wide range of services within a vicinity. For instance, the parking area subcategory could be further segregated into different parking locations, in case certain parking areas are associated with different tenants. These subcategories can then be further divided based on types of expenses, such as snow removal or resurfacing.
To effectively categorize expenses, it is important to have a reliable software. While spreadsheets may suffice for smaller commercial spaces, they can become tedious and prone to human errors in larger-scale environments. With numerous options available, conducting thorough research is crucial. The objective of this blog post is not to endorse any specific software.
The possibilities for categorizing expenses for commercial leases are numerous and depend on the needs and size of the commercial spaces. Ultimately, this step is the foundation of any good commercial lease billing and cannot be skipped, the more detailed it is, the better results it will yield.
TL;DR Checklist Expense categorization:
- Acknowledge if you have diverse lease language due to negotiations and changing standards.
- Categorize expenses into primary categories (e.g., real estate taxes, common area maintenance).
- Create subcategories to tailor expenses to lease-specific requirements.
- Utilize reliable software for accurate categorization.
- Consider software options, especially for larger spaces.
- Highlight the importance of a detailed approach for successful billing.
Diligent and thorough lease interpretation
With or without the assistance of a commercial lease lawyer, it is necessary to perform a diligent and thorough lease interpretation for every new lease. This process ensures that all revenue streams from the lease are properly identified and captured.
At this step, we begin by providing a detailed lease billing summary that includes all billing events and their specifics. Commercial leases can involve a wide range of billing events, such as fixed rent, percentage rent, real estate taxes, common area maintenance, insurance, water consumption, and specific tenant expenses. The summary should include a timetable that specifies the frequency of these events, along with specific dates and any changes to billing, Also. The summary should also include the expense categories and subcategories that are relevant to this specific lease, as discussed in the previous section of this article.
Other information relevant to the billing events should be gathered during this step such as prorated share percentage calculations, renewal options, billings caps and the lease end date.
Calculating the pro-rata share percentage is crucial at this stage. It entails considering factors such as excluding leases that do not participate in expense sharing, including or excluding floors in multi-story contracts, and allowing for future changes to the calculation, such as modifications to the total area of the vicinity. It is important to incorporate all these factors into the summary.
Once the summary completed, the billing events as well as the assignment of expense categories need to be thoroughly incorporated in the billing software used. Not every software contain options for every billing event you will encounter in commercial leases. Tailored notifications, explained below, can help in this situation.
A second review of this step is crucial because the lease summary will incorporate the information obtained in the software used. The information within the lease summary and software will exist for the entire term of the lease, which, depending on the lease, can be a very long time.
TL;DR Checklist for Diligent and thorough lease interpretation:
- Perform thorough lease interpretation to identify revenue streams.
- Create a detailed lease billing summary including billing events, timetable, and expense categories.
- Gather relevant information like prorated share percentages, renewal options, billing caps, and lease end date.
- Calculate pro-rata share percentages accurately, considering various factors.
- Input billing events and expense categories into billing software.
- Ensure the software supports all billing events or use tailored notifications.
- Conduct a second review for accuracy and completeness since the information will last for the lease’s duration.
Automatic updates
A commercial lease usually consists of an initial term and predetermined renewal options that may have fixed or variable increases. Without automation, managing this aspect can become chaotic. The initial term can vary from one year to over five years. During this period, there is a possibility of employee turnover and misplacement of documents. Without proper automation, there is a risk of forgetting a rent increase. By the time it is noticed, valuable investment opportunities may be lost, and it could also be too late.
During the lease interpretation process, it is necessary to set up automatic lease updates, including all renewal options. An effective software will allow you to establish predetermined dates with increases, so that they can be automatically applied when due. If the increases are variable and based on market indicators such as inflation, the software should either have a module to input market data and automatically update the leases accordingly, or incorporate tailored notification as discussed further down.
Fixed rent automatic updates is an option that even the most basic billing software should provide. Automating this simple task alone will save time and avoid the inevitable chaos of human error and staff turnover.
TL;DL Checklist for Automatic updates:
- Recognize the risks associated with manual management, including employee turnover and missed opportunities.
- During lease interpretation, set up automatic lease updates, including renewal options.
- For variable increases based on market indicators, use software with market data input capabilities or incorporate tailored notifications.
- Ensure even basic billing software supports fixed rent automatic updates to save time and reduce errors.
Tailored notifications
Depending on the capabilities of the software you use for billing, or within a task management software, you should set up comprehensive billing notifications. These notifications should prompt the user to either take action for more specific billing scenarios or review a billing batch before it is sent out.
The software should also notify important events such as lease commencement, lease renewal options, lease end.
If the lease summary was well-produced, as discussed above, it should include a timetable that lists all the events that require notifications.
Furthermore, in most commercial leases, there is a specified timeframe for taking action on various events, such as billing events and other important events. It is crucial to include these timeframes in the notification system. For example, a commercial lease might include a six-month period during which a lease renewal can be considered.
Good notifications are key to ensuring comprehensive billing for a commercial lease, especially for lease-specific events such as percentage rent and increases based on market indicators. These events do not occur in the regular billing cycle and can easily be overlooked if not properly notified.
TL;DR Checklist for Tailored notifications:
- Utilize software or task management tools for robust billing notifications.
- Include notifications for specific billing scenarios and batch reviews.
- Ensure notifications cover critical lease events like commencement, renewal options, and lease end.
- Incorporate lease specified timeframes for action on various events.
- Prioritize notifications for lease-specific events like percentage rent and market-based increases to avoid oversight.
Conclusion
By following the guidelines presented in this article, categorized into four key areas:
- Expense categorization,
- Diligent lease interpretation,
- Automated updates,
- Customized notifications,
one can effectively eliminate billing errors and notably reduce billing disputes. While it may be challenging to entirely eradicate billing disputes in commercial leases, given the occasional ambiguity in contract language and the aggressive stance of audit firms, adhering to these practices can greatly diminish such issues and, ultimately, deter the involvement of audit firms.
