When reconciling operating expenses, timing is often pretty straightforward. The tenants make monthly escrow payments throughout the year. The landlord reconciles the calendar year and applies those payments. An additional billing or credit is applied to a tenant’s account.
However, taxes are a different story. While some municipalities bill taxes for calendar years, many bill for fiscal years – often a July – June period. We have worked on properties where there have been multiple types of taxes with multiple fiscal periods. County, school, village using calendar year, fiscal year 7/1-6/30 and fiscal year using 5/1-4/30. As you can imagine, that can really complicate a reconciliation. There are endless numbers of ways to deal with this type of scenario with the most common being to blend to a calendar year. Essentially, you calculate what taxes would be for say 2018 – 6 months of one fiscal year, 6 months of another – using escrows and occupancy for that same calendar year. Consistently applied, this methodology can work really well.
However, there are certain states and municipalities that really throw a wrench into the calculations – where taxes are sometimes billed either a full year in advance or a full year in arrears. In 2018, in some areas, the tax bill being paid could be for 2019, while in other areas, the tax bill could be for 2017!
What does that mean? If a tenant’s lease commenced on April 1, 2018 in an area where taxes are paid a full year in advance, the taxes for 2018 would have been paid in 2017. Therefore, on the day the lease commences, the tenant should be billed for essentially a full year of taxes – the eight month remaining in 2018 and the first four months of 2019 – and then immediately start making additional escrow payments. When their lease terminates, they would essentially be entitled to a full year’s escrow refunds.
If a tenant’s lease commenced on April 1, 2018 in an area where taxes are paid a full year in arrears, the taxes being paid in 2018 are really for 2017, so there would be no tax obligation for that first partial year. When the lease terminated, they would still owe a year plus of taxes.
To combat this timing complexity, many sophisticated landlords will change the lease language to specifically address timing to something along the lines of “taxes for the year will be taxes paid during the year without regard to the period to which they apply.” With that language, for that lease that started on April 1, 2018, regardless of whether it was in a pay for the prior year, pay for the current year or pay for the next year municipality, the tenant would pay its share of taxes paid during that particular year – using the occupancy information and escrows for that year.
The bottom line on this whole timing issue is absolute consistency – in both understanding the periods being billed and how the escrows are being applied – and sticking with that methodology.
Why this issue this week? We are working on a property where taxes are paid a full year in arrears – so the taxes paid in 2018 are for 2017. But there is a lack of consistency. Some of the anchors are billed taxes based upon the period to which they apply while others are billed taxes using amounts paid during the year, while the inlines and outparcels have similar issues. Some escrow, some don’t. And there are material changes in GLA and occupancy among the years. It’s pandemonium!
Do yourself a favor. Shoot for consistency! (And, spend some time really understanding tax periods and how a seller has applied escrows when you are considering a property for acquisition!)