Updated: Mar 10
Clients have begun to ask how the pandemic might affect their lease operating expenses (OPEX) for 2020. Questions abound about whether they should owe less or whether to expect higher bills. Unfortunately, there is no single answer to these questions. Answers are dependent upon a variety of factors that differ from client to client. The first and largest factor (always) is the lease language. Other factors that will affect 2020 OPEX reconciliations include how community mandated and/or unmandated closings were handled, how many tenants were lost to lease terminations, and how each landlord prepared and weathered the logistical impacts of COVID on the building.
OPEX estimates being paid during 2020 were based on pre-COVID budgets. Tenants will not know the potential impact from COVID until landlords begin sending 2020 OPEX Reconciliation Statements beginning in the first quarter of 2021. It is important for tenants to contact Chelepis now to be ready to review those reconciliations closely and take action to address any issues identified.
Here are five key areas that could be impacted by COVID when 2020 OPEX estimates are reconciled:
· Janitorial: Potential reduction in costs from closed buildings with potential increase in costs for extra cleaning, specialized cleaning, and additional sanitation treatments and supplies
· Shared Lobby/Reception Costs: Potential reduction in costs from closed buildings or potential increase in costs for additional staffing needed for specialized tasks like COVID-19 screenings
· Security: Potential reduction in costs from closed buildings or potential increased costs due to demand from COVID-19 safety precaution protocols
· HVAC: Potential decreased costs from closed buildings or increased costs from maintaining constant humidity level and air temperature in buildings for safety precautions
· Utilities: Potential decreased costs from reduced occupancy or increased costs if occupancy adjustments are not applied correctly
The first place to begin when reconciling operating expenses and answering the above questions is to look at the specific lease. Because each lease is unique, there is not one approach for handling all OPEX statements for all tenants. For example, does the lease contain an occupancy adjustment clause, and if so, what does it include or exclude?
Occupancy adjustment clauses (also known as gross-ups) allow landlords to recoup building costs when the property is less than 100% occupied. With COVID-19, there is an increased probability that many buildings were not fully occupied as businesses shut down during the first quarter. The question becomes: How does the landlord equitably calculate the remaining tenants’ share of expenses, especially when there are unanticipated increases and/or decreases in variable and semi-variable expenses? This has always been an important question when occupancy changes and is especially important for 2020 OPEX statements.
Even more uncertainty arises when considering modified gross leases (also known as base year leases) where tenants are responsible for their share of a building’s expenses that exceed the base year specified in the lease. Comparing 2020 OPEX impacted by COVID-19 with a pre-COVID year could cause issues. For example, what if 2015 was a tenant’s base year and the ensuing years saw “normal” increases in expenses, then unexpected expenses happen in 2020 because of COVID-19. How do those increased expenses get fairly passed through to the tenant? What expenses triggered by COVID are allowed by the lease? Also consider a new lease negotiated pre-COVID with a base year of 2020; how will the parties determine what expenses unique to COVID should be included in the base year? Careful examination of the lease language and future reconciliation statements will be imperative as tenants move forward.
Finally, much has also been written about Force Majeure language or language that addresses what happens if an event out of the control of the parties in a contract occurs. If a lease has such a clause, it will depend what exactly that clause states to determine how it might be applied to operating expenses. Most clauses were not written in anticipation of a government closing businesses due to a pandemic, and it is still very early in the litigation cycle; so it is difficult to predict how these clauses will be interpreted by the courts.
From Force Majeure clauses to gross-ups to specific expenses, questions about COVID-19 and OPEX reconciliations run the gamut. Now is the time to become familiar with the operating expenses and audit clauses in your lease. Chelepis is here to answer your questions and help you prepare for any potential impact of COVID-19 on 2020 OPEX reconciliations.
Our success is based on knowledge of how each occupancy dollar is consumed, calculated, and billed. We offer more than the big accounting firms. We offer real estate industry experience from an operations, accounting, and engineering viewpoint—proven experience not offered by any other firm in the industry.
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