A Management Fee Puzzle For Tenants

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It appears to be generally accepted, though we don’t know why, that management fees are validly included within common area costs (a.k.a. “operating expenses”). We take comfort in something that John Stuart Mill wrote in On Liberty: “It is as certain that many opinions, now general, will be rejected by future ages, as it is that many, once general, are rejected by the present.”

To Ruminations, management fees should be treated as a cost of ownership, not an expense for items that benefit a tenant. The property owner can choose to self-manage what it owns or, in the alternative, it can do little or no work and treat its shopping center or other property as if it was a share of stock in General Motors. It is one thing to seek recovery for the administrative overhead cost of managing the common areas, but quite something else to seek recovery for the cost of managing tenants, working on leasing of the property, dealing with financing issues, bookkeeping, preparing tax returns, and for the performance of similar tasks.

For those who haven’t thought about it, let’s be clear how a management fee works. Almost always, a management fee constitutes payment equal to a certain percentage of the total revenue received by the landlord from its property. A typical management fee would be 4 to 5%, though other rates are not uncommon. So, to begin with, if the management fee were 4 to 5%, and a tenant was responsible for paying its share of the management fee, it would be paying approximately 4 to 5% of its rent as part of the management fee. Yes, if it tenant thought its rent was $100,000 per year, and it agreed to pay (or reimburse) it’s landlord for the “management fee,” then it would be paying $4,000 to $5,000 extra on top of its own rent, just for the “privilege” of paying rent. To be more precise, it would be paying its share (generally based on the floor area of its leased space) of 4 to 5% multiplied by the total rent received from the property. It would also pay 4 to 5% based on the total revenue received by the landlord from it and other tenants on account of operating expenses, taxes, and similar pass-through items. It would not be unexpected that the management company is collecting a management fee based other revenue as well, such as monies received from insurance claims. It would not be unheard of if the management fee were imposed on refinancing proceeds, though that would be such a “good deal” for the property owner.

Depending on how the landlord’s management agreement is written, the management company might be receiving a “management fee” on construction costs.

Basically, even if the tenant is willing to pay its share of the management fee, it likely has no idea what is included within the management fee. All it will know is that the percentage used to calculate the management fee is, in effect, a surcharge on all of the payments that the tenant makes to its landlord. Assuming that all tenants are paying the same per-square-foot rent and pass-through amounts, and that all tenants are paying a proportionate share based on the floor areas of their respective leased spaces, then whatever percentage is used for the management fee really constitutes a “private tax” on every payment made by the tenant to its landlord.

As we have written many times before, Ruminations believes that parties to an agreement should be free to reach whatever economic arrangements are mutually satisfactory. We fully understand the concepts of bargaining power, practices in the relevant market, and freedom to contract. We also well understand that people, even lease negotiators, make agreements without fully understanding consequence of such agreements without having comparable knowledge to that held by the person on the “other side” of the deal. How often, when agreeing to pay a proportionate share of a landlord’s management fee, has anyone asked, “What goes into the management fee?”

It puzzles us why anyone would freely agree to pay its share of an administrative fee based on a property’s operating expenses as well as pay its share of a management fee. In addition, the “management fee” is often included within the definition of operating expenses. When that happens, we are also puzzled why anybody would pay an administrative fee based on such an embedded management fee. In fact, if the tenant is going to pay its share of a management fee, why should there be an administrative fee based on the property’s operating expenses? Perversely, if the management fee was 5% of the landlord’s revenue and there were a 15% administrative fee on top of that, the effect would be that the affected tenant would be “taxed” as if the management fee were more than 5.75%.In effect, the landlord would be making money on the fact that it was paying a management fee to someone.

Ruminations well knows that a measurable number of its readers will have found nothing new in today’s posting. We are also aware, however, that there are a lot of readers who have never thought carefully about “management fees.” We only have one weekly version of Ruminations. So, for those readers unsurprised by today’s thoughts, we hope that you have found at least one diamond in the rough. For those who haven’t previously thought about this subject, Ruinations hopes that today’s posting will add to your negotiation knowledge base.

Nothing we’ve written today should be taken as our opinion that management fees should never be picked up by a tenant. For example, if all rents in the relevant marketplace are quoted on the basis that there will be a management fee on top of the basic rent, then tenants, when comparing one location against others, will not be misled. That doesn’t mean that a tenant should not inquire about the cost impact of management fees on total occupancy costs, but only that every other quoted rent needed to be “adjusted” by the management fee “surcharge.”

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Comments

  1. Randall Gunn says:

    Great article. The legal sde does not always appreciate the business side. The only thing I would add is that there are some landlords who seek and demand in their leases 4 or 5% of the rent AND a $/SF for the management fee.

    This inclusion of costs for tradition of having the cost is reminiscent of “porters wages” being included in the operating expenses for leases decades after elevators went to self service.

  2. In our practice of providing lease audit services on behalf of tenants, we often have discussions and/or disputes with landlords regarding management fees. A few observations:
    1) if the definition of Operating Expenses in a lease does not include management fees, the landlord should not include such fees; and
    2) watch out for landlords that hire 3rd party management firms, but then collect management fees in excess of what they pay those property management firms, and
    3) as mentioned in the article, it is a good idea to check the revenue on which the management fee is calculated. For example, watch out for security deposits, lease termination income, etc.
    Thanks for writing about this important topic.
    Bob Wiesner, Senior Partner – The Robert Thomas Group Lease Auditors – rtgaudit@aol.com

  3. If a Landlord insists on mgt fees and an admin fee (which is double dipping by any measure but too many tenant real estate folks are judged by ‘deals done’ instead of ‘good deals done’) than at least specify that Mgt fees etc. are only due on ‘common area costs’. Landlord Mgt fees encompass much more than common area work efforts. rent collection, estoppel prep, marketing fees, etc. have no bearing on common area expenses and should not be charged through.

  4. It is here that the lease language defining common area expenses is so important. The definition which says “including the costs of managing the common areas” is not the same as language saying “including the costs of managing the shopping center”. If a tenant does agree to pay an administrative fee read the clause carefully to make sure things like real estate taxes and public sewer charges are not included. The landlord is clearly not entitled to a fee of $15,000 for simply mailing a $100,000 check to the tax collector.

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