Every year at this time, we wait with bated breath for the spring renewal of all things beautiful, and somewhere in the middle, everyone scrambles to ensure their regular dance with the IRS is complete, and funds are exchanged. This same dance happens in retail at a much larger scale, in an episode that I now call the “Escrow Surprise!” It’s almost like an Easter egg hunt but not quite as full of childlike joy.
Every year, retailers’ leases require them to place funds in escrow (a prepaid an estimated expense, typically divided equally between twelve months) toward their portion of the Landlords’ annual tax billings. At the end of every year, Tenants receive a reconciliation of their share of the tax obligation, less what they have already paid toward that obligation, with a balance or credit due based on the actual assessments.
This year, as opposed to prior years, we are seeing wide variances in these estimated tax payments (escrows) and the final reconciliation. These variances often create large outstanding balances for retailers, sometimes in the tens of thousands of dollars. Whether this is a product of the government’s late-to-update property assessments, or owners/Landlords being behind in recognizing the increased obligations to retailers, the Escrow Surprise can cause angst for a Tenant with this new, unaccrued, and hefty financial obligation, particularly in an industry that has hit a wall.
We have some thoughts about protecting yourself. When it comes to commercial real estate tax escrows for retailers, both Landlords and government agencies play a crucial role in ensuring that these payments are made timely and accurately. In order to avoid missed escrows, it’s important for both parties to take proactive measures to stay on top of their responsibilities.
For Landlords, this means regularly reviewing their property tax bills and ensuring they are paid promptly. In jurisdictions where they are given discounts for early payments, they should seize these opportunities unless they plan to appeal. They should also keep accurate records of these payments and provide copies to their tenants as proof of payment. Additionally, landlords should communicate with their tenants regarding any anticipated changes in property taxes, new levies, or other fees that may impact their lease agreements.
Government agencies also play a critical role in preventing missed escrows. They should provide clear and concise information about property taxes, including due dates and payment options. They should also have accessible systems to track payments and ensure they have been properly credited to the appropriate accounts. Finally, government agencies should be responsive to inquiries and concerns from Landlords and provide assistance when needed to ensure that tax payments are made on-time.
Overall, the key to avoiding missed escrows in commercial real estate is clear communication, careful record-keeping, and proactive measures on the part of both landlords and government agencies. By working together, they can help ensure that Landlords are not burdened with unnecessary penalties or fees that cannot be passed on to the retailers.
How Retailers Can Protect Themselves
Most leases contain protection for the Tenant to avoid overpaying on expenses that are ultimately passed on to the Tenant (a pro-rata obligation). These come in the form of exceptions wherein Tenants are not responsible for fees assessed to the Landlord, or that Tenants are not responsible for paying at a rate they would otherwise pay, if they were paying these directly to the agency, county, or provider, especially with utilities.
Certainly over the past few years, what first seemed to be anomalous weather events that brought increases in Tenant-related expense for electrical, gas, HVAC, trash, insurance, snow and ice removal costs; appear to have quickly become the basis for escrow increases to these expenses passed on as an anticipated cost for the Landlord. Whether or not the logic holds, cost increases have propelled Landlords to bill at higher rates with the understanding that these “one-off” weather events are now a part of their anticipated costs, ultimately burdening retail Tenants with more upfront cost, and with the hope that they do their due diligence in reconciling these expenses correctly at the end of their periods, crediting any overpayments back to the Tenant.
For newer retailers, or retailers who are looking to renegotiate their leases, moving toward fixed-rate expenses (as often as possible) simplifies their portfolio and helps them to account for these expenses over the lifetime of their leases (read: ASC842, rent accounting). These fixed expenses, often with fixed increases each year, are easier to maintain and prevent any surprise costs from being passed through to the Tenant. A great example of this was the case with the Texas power outages of 2021.
Communication Is Key
Typically Landlords and Tenants have some form of process in place that is standardized for them. Landlord’s lease agreements, while potentially standardized for the larger national and international management companies, still have unique-to-Tenant language that must be reviewed and challenged by Tenant’s teams.
What we’ve learned over a period of time is that for many Landlords, utility expenses, additional Insurances, and overall increases to operating costs have been rarely communicated in a way that is justifiable to the Tenant or their leasing teams. Even when they are justified, clear communication is the best way to ensure trust in the Landlord-Tenant relationship, either by providing budgets in advance when Landlords anticipate escrow increases, or by more quickly making escrow adjustments on expenses when a reconciliation has been done and Tenant has any kind of credit or additional obligation (i.e., have been sent a Year End Adjustment).
Outsourcing Lease Management Can Help Protect Tenants
The onus is, unfortunately, on the shoulder of the Tenant at most times to push back on the Landlords when caps, fixed increases, and unallowable expenses are billed through on real estate taxes. However, it is the responsibility of the Landlord to, when appropriate, respond quickly when these discrepancies and disputes are presented, rather than tread water when a Tenant presents evidence of disparities. Preservation of the Landlord-Tenant relationship here is crucial when Tenants go to reevaluate their terms and any future lease agreements, and ultimately will impact the entire retail sector if- or when- Tenants evaluate their footprint in the physical retail marketplace.
