GUEST COLUMN: Automated Recoveries Key for Efficient, Effective Lease Administration

“Efficient and effective” has become the mantra of choice for busy commercial real estate owners and managers. Nowhere is this more applicable than in lease administration, especially in current challenging times when survival can depend on successfully collecting money due, and accurately managing revenues and pass-throughs.

The commercial real estate industry forfeits billions of dollars of revenue and valuation each year. Why? Because the lease terms that entitle them to recover operating expenses from tenants are frequently interpreted, calculated, billed and applied incorrectly.

A surprising number of real estate professionals still calculate expense recovery billings manually, without a high degree of automation. Many utilize spreadsheet programs – which generally goes strongly against the drive toward efficiency and effectiveness. According to NAREIT statistics, only 70 to 80 percent of eligible operating expenses are recovered due to errors and associated administrative costs.

To begin, the cost of calculations can be significant, particularly for companies with large portfolios. Tenant recoveries represent approximately 25 to 33 percent of gross revenues for commercial real estate companies. Employees can spend countless hours shuffling through formulas to accommodate changes through the life of a lease. Worse yet, unavoidable human error can lead to costly omissions and mistakes.

While this is true across commercial sectors, it is particularly applicable to the highly specialized, complex field of retail management. So much of retail lease administration hinges on the issue of recoveries involving percentage of sales, taxes, operating costs, utilities and other items. Tremendous variation exists in lease terms, based on an assortment of factors that impact how much each tenant will pay. Administrative fees, too, differ considerably from those typically incurred in office properties.

In a typical office building, the percentage of operating expense reimbursement is stipulated in the lease agreement. In a shopping center, however, a tenant’s reimbursement percentage is generally based on a formula. While the numerator of such a formula is straightforward, the formula for the denominator is often quite complex. These denominator formulas will typically contain excluded areas and occupancy factors within the calculations.

Much of the complication arises out of the need to adhere to recovery terms dictated by anchor tenants. This creates a strain on calculating the formulas for the anchor as well as the smaller tenants. A mall manager might very well end up with 40 different denominator calculations for 40 different tenants. The calculations are further complicated if – as has happened in the current economic downturn – vacancies rise dramatically.

The Good News

On the bright side, technology has evolved to allow for integrated, automated expense recovery systems that not only save extraordinary amounts of time but also provide a proper structure and audit mechanism to minimize or eliminate errors. The IBS system, for example, creates each lease using the core lease information and then inherently adjusts for changes in key factors through its term.

As a result, the personnel requirement becomes more of an audit function than that of a calculation function. Additionally, the existence of a demonstrable, tightly integrated escalation system is highly valuable in resolving tenant disputes and actually may lead to a reduction in disputes based on the customer being more confident in the landlord’s administration skill.

As further good news, commercial and retail owners and managers have become increasingly focused on seamless integration of their core accounting functions with other third-party applications, such as work order programs, document management programs, etc. At IBS, we take pride in the sophistication of our integration software. We are meticulous in analyzing the data mapping and transformation between our system and a number of leading third-party applications.

The next step in real estate management technology will involve maximizing the potential of the Internet as a means of connectivity among various management-related systems. From lease collaboration to electronic disbursement of invoices and accounts payable, best-of-breed solution integration is providing interesting returns on investment as owner/operators look to extend their use of technology to become more efficient.

Getting There

Yes, fully integrated solutions do exist and are achievable. Yet while reaching this level of automation is a clear goal, the challenges involved in implementing a new system can be daunting – and exponentially more so as the size of the portfolio and complexity of leases increases.

The core system must be solid, able to capture an incredible level of detail, and flexible enough to handle the most sophisticated lease structures. And it is critical to work with a vendor that not only provides a premier-quality system but backs it with superior training and support services.

Making the transition takes time and trust. However, once the right system is in place it can lead to great things in the quest to achieve the most efficient and effective lease administration operations.