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Variable outgoings — how best to manage and reconcile them

Variable outgoings — how best to manage and reconcile them

by Raymond Bechard 0 comments

Variable outgoings (VOs), also called operating expenses, outgoings or common area maintenance (CAM) as they are called in the US, are charges to a tenant that are recoverable as per their lease agreement. They relate to general or common area costs incurred in operating, repairing or maintaining a property.

Type of expenses normally included in VOs are council rates, water and sewerage rates, land tax, insurance premiums, air conditioning, cleaning expenses, fire protection, pest control, repairs and maintenance, security, rubbish removal, signs, gardening, etc.

VOs charges normally apply to commercial, retail or industrial tenants who have signed net lease agreements as opposed to gross lease agreements. Net leases include a provision requiring the tenant to pay a portion of the taxes, fees and maintenance costs of a property in addition to rent. These additional charges are the VOs.

There are two main methods of recovering VOs costs.

1. Actual or directly recoverable

Based upon actual costs incurred, each cost or expense item needs to be apportioned to the tenants based upon the percentage of the area they occupy of the total lettable area of the property or other justifiable apportionment method. This method is also called directly recoverable as the costs are directly recovered from tenants each time a cost is incurred.

This method results in each tenant receiving numerous charges to their account, one for each bill that gets paid relating to a VOs cost centre.

2. Budgeted outgoings

Based on budgeted VOs costs of the property for the financial year, tenants are charged a fixed amount each month which is then adjusted at year-end based upon actual costs incurred.

This method results in the tenant receiving a fixed charge each month and a one-off adjustment after year-end when the VOs reconciliation is complete.

Pros of each method

1. Actual or directly recoverable

This method is arguably more accurate as each cost can be allocated to tenants directly based on the nature of the expense and the most appropriate apportionment method.

This method can be beneficial for cash flow in a property. For example, if the land tax or council rates bill comes in and is dealt with promptly, the Property Manager can invoice the tenants and receive payment before the land tax or council rates bill needs to be paid. The owner’s cash flow is not negatively impacted.

No VOs reconciliation is required and no audit is required.

It is arguably easier to deal with when a tenant is vacating their premises during a financial year, as an adjustment is not required if all expenses have been accounted for up to the vacating date, except perhaps for statutory charges which might still require adjustment.

2. Budgeted outgoings

Charging VOs is a large time saver during the year as the budget for each tenant is set once and the tenants are automatically charged the budgeted amount monthly for the year.

This is the only viable method for properties with multiple tenants — say, over 10 tenants — otherwise, the other method would be too time-consuming.

Charging VOs forces the Property Manager to calculate a budget, which instills good discipline while also benefits the tenant who can budget for their cash flow.

The Property Manager also normally completes the full property budget, which enables the owner to budget for their investment property income.

This is the most commonly used method and is commercial best practice in the industry.

Cons of each method

1. Actual or directly recoverable

This method is the least efficient as each individual cost needs to be apportioned across the tenants and is normally associated with providing tenants with supporting documents for each charge. This is a large administrative burden on Property Managers, slightly eased by using good property management software that facilitates this.

The opportunity cost of the additional Property Manager time this method consumes normally outweighs any audit costs of method two if applicable.

This method makes it a lot easier for tenants to challenge the allocation of costs to them and argue for the application of a method that is more favourable to them. For example, tenants occupying an outside area of a shopping centre might argue that they should not pay for common area electricity in proportion of their lettable area is to the total lettable area.

Tenants receive multiple charges on their invoice that vary from month to month, which also make their cash outflows variable and difficult to budget for.

This method also results in the owner needing to cover the costs relating to any vacant space.

2. Budgeted outgoings

When this method is used, then a VOs reconciliation needs to be done at financial year-end, and sometimes depending on the lease or legislation, it will have to be audited, resulting in an additional cost.

In Australia, legislation requires retail lease VOs reconciliations to be audited, while in some states only 50 per cent of the audit cost can be included in the VOs costs of the property. Meanwhile, if the VOs reconciliations are audited for commercial leases, the audit cost can normally be included in the VOs costs.

The reconciliation normally consumes large amounts of Property Managers’ and Trust Accountants’ time unless the Property Management system facilitates this being done easily. This results in the July to September period in Australia being the busiest period, and this can often be visibly seen in affected staff who can burn out easily, sometimes resulting in high staff turnover in those roles.

Outsourcing this functioning or utilising good property management software that facilitates this reconciliation can ease the burden.

There are deadlines that must be adhered to, some of those legislated, such as for retail tenants whereby tenants need to be advised of the new VOs charge a month before the charge starts.

If not managed proactively, this method could result in the owners’ remittances being lower in certain months during which there are large cash outflows (for example, council rates) while the tenant receipts are spread evenly over the year.

A VOs reconciliation is normally only done at the end of the financial year (although some software does facilitate interim reconciliations). Thus, if a tenant vacates a property during a financial year, it could be some months before their adjustment is known. If there is a shortfall, it is not always easy to recover from a tenant who vacated months earlier, which is sometimes dealt with by holding a deposit or by being conservative in the budgeting process.

In conclusion, the pros of charging VOs on a budgeted basis far outweigh the cons, is commercial best practice and preferred over the directly recoverable method, especially if your property management software facilitates a streamlined VOs reconciliation process.

Variable outgoings — how best to manage and reconcile them
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Raymond Bechard is a Director of cirrus8; a Chartered Accountant and  Chartered Management Accountant who has been developing property management and trust  accounting solutions for the commercial property industry for over 15 years. 

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