HOUSTON – (Realty News Report) – The devil, they say, is in the details, and no one is more aware of that than Bill Brownfield. Along with Larry Mayerhofer (CPA), Brownfield co-authored The Escalation Handbook for Office Buildings, first published by the Building Owners and Managers Association (BOMA) in 1991. The book remains very popular with property managers, property accountants and owners because it brings some structure to a very confusing topic – one that just happens to generate 15% to 50% of total income for multi-tenant office buildings. Realty News Report sat down with Brownfield to discuss the book’s success, the game plan for Alpha Office Escalations (AOE) and what is expected to happen in the Houston office market in the years ahead.
Realty News Report: You’ve worked in the Houston office market for years, how would you describe landlord sentiment as we move into the fourth quarter?
Bill Brownfield: It seems like there are two very different points of view developing in Houston, especially in the CBD and some concentrated developments in the suburbs. Landlords of the newest Class A+ projects are offering amenity-heavy services, mirroring hospitality levels offered by high end hotels in order to attract the strongest tenants. They’re well capitalized, have market mojo and momentum, and tenant interest is moving in their favor because they can offer live/work/play environments for those willing and able to pay premium rents. Contrast that with landlords of older second tier Class A and Class B office buildings. These are the majority of owners across Houston, and their product is at risk of being treated as commodity space, meaning they compete mostly on price. Yet they still need to allocate new capital to reposition their buildings just to keep up. On top of these issues, all owners are facing rising property taxes and slackening demand by the oil and gas sector. So, it’s a very competitive environment across the city. Almost a quarter of office inventory is vacant and even positive factors like population growth and job growth aren’t quite strong enough to overcome the negatives.
Realty News Report: What about other markets?
Bill Brownfield: Our business is national in scope. Most of our current online client base is spread across the Sunbelt and coastal cities, where population growth and job growth keep wind in the sails. These markets face rising costs as well, but many are cautiously optimistic that their economies will continue to grow.
Realty News Report: Bill, you’re a best-selling author with the Escalation Handbook for Office Buildings, which is now in its third edition. How did it all get started?
Bill Brownfield: Literally on a napkin at my kitchen table, like so many other stories you hear about!! Back in the 1980s, almost everyone including a few landlords thought that the ‘gross up’ provision in an office lease was unfair to tenants and believed it would allow a landlord to collect more than was spent on operating expenses. Anyway, I drew a chart on a napkin to see if it was true (it’s not) and the rest of the book grew out of that — mainly so I could use it to train our property managers. It was first published by BOMA International in 1991 and they’ve sold it continuously ever since. We’ve been very fortunate that it’s remained relevant all of these years, though being called the ‘King of Gross Ups’ was never one of my expectations! Larry Mayerhofer is my co-author on the current third edition, and with his help we expanded it from a training book to a complete billing system that landlords can use for escalations. Larry’s a CPA and he ran the national property accounting department for Equity Office Properties when we worked there. He used the handbook’s methodology to create EOP’s escalation billing system. It was the largest office REIT in the country before it was sold to Blackstone, so Larry’s experience with escalations is really unmatched. The book remains very popular with property managers, property accountants and owners because it brings some structure to a very confusing topic that just happens to generate 15% to 50% of total income for multi-tenant office buildings. And due to the popularity of the book, we created a software product to automate the entire billing and invoicing of escalations. It’s now an online cloud based SaaS subscription service.
Realty News Report: How many of these books have you sold?
Bill Brownfield: A lot. I estimate thousands over the past 28 years. BOMA International handles all of the book sales and we get a modest quarterly royalty check four times a year. But we haven’t kept track of total sales, so I honestly don’t know how many. Over the years, lots of folks have shown me their well-worn copies too – even some homemade copies, but we’re okay with that. Our goal from the beginning was to create an industry standard to solve a problem. Based on our book sales, we’ve established a workable, standardized methodology for escalation calculations. Now our goal is to automate escalation billings with Alpha Office Escalations. One side effect of doing that is to improve the level of trust between landlords and tenants.
Realty News Report: And the book maintains its popularity?
Bill Brownfield: It’s pretty unique for a business publication to have such a long run, and a good question to ask is “Why?” I think it’s because there are a lot of real estate professionals who (a) recognize how complex escalations are and (b) also see how often errors are made when billing tenants. Almost everyone I’ve met in this industry wants to do the right thing, and in this case it means they want to honor the terms of each lease that they’re responsible for. So they take the time to learn how to do it better.
Realty News Report: For people who don’t work in office leasing, how do you define escalation clauses?
Bill Brownfield: Escalations is just a fancy word that defines how much of the building’s operating expenses should be paid by each tenant. The answer to the question gets very complicated, though, because every office lease is negotiated separately and has unique provisions that impact what the landlord pays and what each tenant pays. The beauty of our billing system is that it’s flexible enough to capture 99.9% of these unique provisions.
Realty News Report: And your company software product, Alpha Office Escalations, can you describe it briefly?
Bill Brownfield: Yes, on the surface, AOE is a billing system that automatically and correctly calculates each tenant’s share of operating expenses, in accordance with each unique lease item, expense cap or capital amortization. All a user needs to do is upload expenses, input each lease’s economic terms, and set up expense pools. Then AOE does everything else. But AOE is more than just a billing system. The structured input process eliminates costly calculation errors ‘hiding’ in homegrown Excel schedules and 20+ reports help the landlord survive operating expense audits. More importantly, AOE shows the owner exactly how much of the building’s operating expenses they are subsidizing because of vacancies and gives the owner useful information to improve the outcome.
Realty News Report: What about office leases today? Have you noticed any new wordage, clauses or trends that have emerged into leases lately?
Bill Brownfield: The basic legal language of OpEx and CapEx clauses for office leases hasn’t changed much for 50 years. The lack of change suggests the basic structure is sound and has stood the test of time. That said, definitions of what will be paid by each tenant are negotiated in every lease. That’s what tenant reps and landlord reps do every day. Some major expense categories do get tweaked on occasion — margin taxes were a few years ago, for example. An emerging trend today is adding language to define who will pay for the new amenities and services, including fitness centers, concierge services and conference centers and related staffing. Those costs are incurred for the benefit of the tenants, so landlord lease language will be included to allocate those costs to tenants for their pro-rata shares.
Realty News Report: We’ve heard that offers of free rent still exist in offices leases signed in Houston lately. But that trend may be moderating. Can you comment on that?
Bill Brownfield: Free rent is still being offered and lease terms are often extended to match the number of free months. Tenant improvement budgets are also increasing to attract certain tenants, which means that some landlords are acting like lenders and rolling extra tenant improvement costs into rental rates or extended terms to pay for them. These concessions will continue until overall occupancy improves substantially.
Realty News Report: Back to your book, for a moment. Do you have any plans for a fourth edition?
Bill Brownfield: Not until major changes in lease language or lease structures occurs. Our main focus going forward is adding to our AOE software subscriber base. It’s growing nicely because it’s a niche service that no one else offers. The large property accounting software packages don’t handle escalations very well, but we do. One day those companies will decide to plug that hole, and we will be ready to help them create perfect escalation invoices.
Realty News Report: Lastly, as we approach 2020, do you have any predictions for real estate or the economy?
Bill Brownfield: The office industry has faced and overcome lots of difficulties in the past such as the Y2K scare, the Great Recession, and oil busts galore. Today’s concerns are numerous too: trade wars and related tariffs, higher construction costs, unrelenting increases in property taxes, declines in oil prices, and uncertainty about the impact of technology on how office space will be used in the future. I believe the industry will survive these problems too. Growth, creativity, property conversions and access to capital tend to solve most problems. We have an abundance of each in Houston and in Texas.
Oct. 29, 2019 Realty News Report Copyright 2019