David Zeve

Monday, 22 July 2002 10:09

Being blind to costs

It comes as no surprise to me that questions and complaints about 401(k) fees have surfaced. As these retirement plans multiply, participants are finding out that the difference between, say, 1 percent and 3 percent in annual costs will add up to a large chunk of change over the long haul.

Retirement plan expenses can be hard to pinpoint. One problem is that few workers know how much their plans charge in expenses, and those who want to find out have a hard time. It's not that their bosses are being secretive; most bosses don't know, either.

Many business owners, especially those of small- to medium-sized operations, are blind to administrative or investment costs. They often lack the knowledge and experience to ask the right questions. Facing complex regulations and fiduciary requirements, they want a well-known company to take the responsibility, and they're not too fussy about the fine print. As plan providers, insurance companies have thrived in this ask-no-questions environment.

The situation can get really murky. While the Securities and Exchange Commission requires mutual funds to file annual disclosure statements that include investment fees, banks and insurance companies have no similar obligation. And no plan has to tell participants how much they're paying for record-keeping, statement preparation, legal costs and other nuts-and-bolts expenses.


The growing cost gap

Reports indicate that the cost gap between the lowest- and highest-cost plans is widening. The most likely reason: Information and fees are often hidden, and few but the smartest players know where to look. And because disclosure is so scanty, companies can't easily compare the fees charged by competing providers.

This means many investors will miss out on big bucks, especially as the impact of compounding grows over several decades. The overall average fee is probably around 1 percent, but for many plans, the number can be as high as 3 percent.

For the plan participant, the dollars-and-cents difference can be dramatic. As the chart below shows, assuming an annual return of 10 percent over 30 years, a person who saves $1,000 a year would have $149,579 in the end-assuming a 1 percent annual fee, but only $102,093 with a 3 percent annual fee.

It's clear that high expenses can be confiscatory, whether in 401(k) plans or in any other investment vehicles. The number of load mutual funds, for example, has increased recently. The most common explanation seems to be that, as a large segment of investors has grown older-and richer, courtesy of the extended bull market, they feel the need for advice.

Some are being led to believe that buying load funds from a stock broker will do the trick. Not likely. Every dollar invested incurs a tariff as high as 5.75 percent. And not all are front-end loads. Some charge a load when you sell; many have 12b-1 fees, annual so-called "marketing" charges that are piled on top of a fund's management and administrative expenses.

What's truly astonishing is that some investors will buy load funds from a financial adviser who also charges an annual management fee, or opt for a broker's wrap account with a yearly toll in the 3 percent neighborhood.


Good times mask high expenses

Because expenses and loads are asset-based, their effect is somewhat blunted during periods of high total return. In the 1980s, for example, the S&P 500 grew at an annualized rate of 17.5 percent. In the 1990s, the S&P's growth rate has been 16.6 percent. The S&P's 30-year average, however, is closer to 12.2 percent, and at that rate of return, two percentage points makes a marked difference.

None of the high-expense routes makes any sense. Equal or better retirement plans and investment vehicles with significantly lower fees can be found. All it takes is homework and respect for a hard-earned buck.

Harvey Zeve is president of H.L. Zeve Associates, Investment Counselors, a Pittsburgh-based investment counseling firm.

Monday, 22 July 2002 10:05

Are you overpaying for electricity?

Electricity is billed in a number of ways, depending on the age and setup of the building. Whatever the process, our goal is to assure that you, as a tenant, pay no more than your fair share. To that end, we'll call attention to the areas in which overbilling commonly occurs and to the steps you can take to prevent it.


Electricity rebilled by the landlord

Landlords who buy electricity at a volume discount and rebill it to tenants often take an excessive markup. They charge the substantially higher rate tenants would pay - because of their relatively low usage - as if they were buying electricity directly.

Thus, the lease typically states that "the landlord may bill the tenant at rates in effect as if the tenant were purchasing the electricity directly from the utility." Your solution: Before signing the lease, find out the landlord's rate and negotiate a "landlord's markup" that includes an acceptable profit margin and the landlord's administrative cost for rebilling. In addition, make sure that the higher rate applies only to the leased premises, not to the common areas.


Prorated billing

Landlords who can't quantify how much each tenant is using normally prorate the bill based on rentable square footage. In this situation, you need to know the "electricity profile" of the other tenants. Do any run large computer installations? What about two- or three-shift operations - telemarketing or data processing, for example? If other tenants' electrical usage is abnormally high, the issue should be addressed during the lease negotiation so that you aren't subsidizing your neighbors.


Allocation

Are all tenants paying their fair share of the utilities? We have sometimes found that common area expenses, which include electricity, are not being allocated properly to for-profit garages, retail tenants and specialized facilities like health clubs and restaurants. When you negotiate your lease, be sure that these issues are taken into consideration.


After-hours HVAC

The most common electricity overcharge is in billing for after-hours HVAC.

These charges, which vary from building to building and city to city, depend on whether the property is old or new and whether the HVAC can be turned on by zone or if whole sections of the building must be turned on to heat or cool one tenant's space.

To arrive at the rate per hour, landlords normally take into consideration utility cost, depreciation, labor cost (if applicable), overhead and profit and, in some instances, repair and maintenance. They bill tenants accordingly and are subsequently reimbursed.

What often happens, however, is that the electricity and labor components of the hourly charge are also included in the expense pass-throughs. The reimbursement, an income item, should be deducted from the pass-throughs but isn't. As a result, tenants are paying twice for the same thing.

This is another subject that should be addressed during lease negotiations. Ask the landlord to specify his after-hours HVAC rate. If you are a large after-hours HVAC user, it is in your best interests to be familiar with charges in other buildings to determine if your landlord's rate seems to be in line. In addition, make sure that the definition of operating expenses states that "any expense reimbursements" will be reflected as an offset to pass-through operating costs.

Electricity is just one of the many components of expense pass-throughs, which, together, constitute an increasingly greater portion of occupancy costs. Errors in calculation, overcharges and items that are not the tenant's responsibility appear with enough frequency to merit your attention. Regular monitoring and lease audits when you suspect discrepancies that can't be easily resolved are your best antidotes.

David Zeve is president of David J. Zeve Associates, a Pittsburgh-based commercial real estate firm that represents tenants and buyers exclusively. David J. Zeve Associates is a member of ITRA, the International Tenant Representative Alliance.

Information for this article was provided by Sid Rattner, partner, Friedman Eisenstein Raemer and Schwartz, a Chicago-based CPA firm.

Monday, 22 July 2002 10:10

Real estate

Are you overpaying for electricity?

Electricity is one of the most common pass-through expenses; it can also be among the most abused.

By DAVID ZEVE

Electricity is billed in a number of ways, depending on the age and setup of the building. Whatever the process, our goal is to ensure that you, as a tenant, pay no more than your fair share. To that end, we'll call attention to the areas in which overbilling commonly occurs and the steps you can take to prevent it.


Electricity rebilled by the landlord

Landlords who buy electricity at a volume discount and rebill it to tenants often take an excessive markup. They charge the substantially higher rate tenants would pay-because of their relatively low usage-as if they were buying electricity directly.

Thus, the lease typically states that "the landlord may bill the tenant at rates in effect as if the tenant were purchasing the electricity directly from the utility."

Your solution: Before signing the lease, find out the landlord's rate and negotiate a "landlord's markup" that includes an acceptable profit margin and the landlord's administrative cost for rebilling. In addition, make sure that the higher rate applies only to the leased premises, not to the common areas.


Prorated billing

Landlords who can't quantify how much each tenant is using normally prorate the bill based on rentable square footage. In this situation, you need to know the "electricity profile" of the other tenants. Do any run large computer installations? What about two- or three-shift operations-telemarketing or data processing, for example? If other tenants' electrical usage is abnormally high, the issue should be addressed during the lease negotiation so that you aren't subsidizing your neighbors.

Allocation

Are all tenants paying their fair share of the utilities? We have sometimes found that common-area expenses, which include electricity, are not being allocated properly to for-profit garages, retail tenants and specialized facilities such as health clubs and restaurants. When you negotiate your lease, be sure that these issues are taken into consideration.


After-hours HVAC

The most common electricity overcharge is in billing for after-hours HVAC.

These charges, which vary from building to building and city to city, depend on whether the property is old or new and whether the HVAC can be turned on by zone or if whole sections of the building must be turned on to heat or cool one tenant's space.

To arrive at the rate per hour, landlords normally take into consideration utility cost, depreciation, labor cost (if applicable), overhead and profit and, in some instances, repair and maintenance. They bill tenants accordingly and are subsequently reimbursed.

What often happens, however, is that the electricity and labor components of the hourly charge are also included in the expense pass-throughs. The reimbursement, an income item, should be deducted from the pass-throughs but isn't. As a result, tenants are paying twice for the same thing.

This is another subject that should be addressed during lease negotiations. Ask the landlord to specify his after-hours HVAC rate. If you are a large after-hours HVAC user, it is in your best interests to be familiar with charges in other buildings to determine if your landlord's rate seems to be in line. In addition, make sure that the definition of operating expenses states that "any expense reimbursements" will be reflected as an offset to pass-through operating costs.

Electricity is just one of the many components of expense pass-throughs which, together, constitute an increasingly greater portion of occupancy costs. Errors in calculation, overcharges and items that are not the tenant's responsibility appear with enough frequency to merit your attention. Regular monitoring and lease audits when you suspect discrepancies that can't be easily resolved are your best antidotes.

Information for this article was provided by Sid Rattner, partner, Friedman Eisenstein Raemer and Schwartz, a Chicago-based CPA firm.

David Zeve is president of David J. Zeve Associates, a Pittsburgh-based commercial real estate firm that represents tenants and buyers exclusively. David J. Zeve Associates is a member of ITRA, the International Tenant Representative Alliance.

Monday, 22 July 2002 10:09

Bricks of gold

They don't appear on balance sheets, yet they deliver the tax benefits of ownership. They're called synthetic leases, and their positive impact on corporate profitability can be dramatic.

The market for synthetic lease structures is growing almost exponentially. In fact, in the past three years, one West Coast law firm alone has been involved in deals worth more than $3 billion, for a total of 7 million square feet.

There are a number of reasons for this almost-explosive growth, not the least of which are changes in corporate strategies and tightening real estate markets. In an era marked by downsizing, restructuring, reengineering and a zealous search for increased profits, real estate occupancy costs have become a prime target for cutting expenses and enhancing bottom lines.

Corporations have reduced the space-per-person allotment; created virtual offices where employees, supported by computers and telecommunications, work from their homes and other sites; and allotted desks and offices on a temporary, as-needed basis. Still, they continue to search for other sources of cost-savings. And with office markets reaching saturation points and rental rates soaring, constructing their own facilities has become the solution of choice for many companies. Once committed to that route, they then seek the most advantageous way to structure the financing.

For many, synthetic leases are the hands-down winner. Users can now be counted in just about every American industry, and interest is spreading to Europe and Asia.


A definition

A synthetic lease is off-balance-sheet financing. It gives the user the benefits of a capital transaction for tax purposes and an operating lease for accounting purposes.

In simplest terms, a typical transaction works like this: A corporation needs a new facility (office or industrial building, theater, hospital, etc.). A capital source or lessor buys the real estate from the developer and leases it to the corporate user, who may buy the property at a predetermined price when the lease expires.

Looks simple, but it isn't. The lease must meet critical accounting guidelines if it is to deliver its intended advantages. Among these are:

Stronger balance sheets. Balance sheets show neither the leased property nor the associated liability, which results in better financial ratios. Lease payments are reported as current expense.

Tax benefits. Users are considered owners for federal income tax purposes, which entitles them to take depreciation and to deduct the interest portion of the lease payment.

Total control. Users control all the functions of ownership, including potential gain or loss, operational control and responsibility for expenses.

Multiple financing opportunities. Commercial paper, private placements, banks and other funding sources are readily available.

Lower occupancy costs. Corporations that qualify for synthetic leases typically realize substantial long-term savings or find that they can afford a higher-quality property than would be possible with traditional financing. They can normally borrow at the corporate finance rate, which is lower than the higher interest rates typical of real estate financing.


History

Synthetic leases were first introduced in the late 1980s but remained relatively unknown until the past few years. Initially, each was virtually one-of-a-kind. Increased popularity has led to more standardized accounting and documentation and, consequently, to lower fees.

Today's typical users are large corporations with solid credit ratings, but it seems likely that smaller, financially sound companies will follow the trend.

A synthetic lease is limited to new construction or properties to be constructed. It can't be used if a corporation already owns the property.


Caution

In spite of glowing reports, synthetic leases are not without certain risks apart from those inherent in any real estate venture. Because this less-traditional financing is complicated and not yet widely used, many real estate and financial professionals don't know all the ins and outs. And if a deal violates any of the very strict accounting criteria, it won't fly. So you would want to consult only experienced real estate, legal and accounting professionals who are experts in synthetic leasing and who can also help you determine whether it will support your company's business strategies and objectives.

David Zeve is president of David J. Zeve Associates, a Pittsburgh-based commercial real estate firm that represents tenants and buyers exclusively. David J. Zeve Associates is a member of ITRA, the International Tenant Representative Alliance. ITRA members are located in all major markets throughout North America.