Let’s start with the easy stuff.
Common area maintenance charges, or CAM charges, are defined by USLegal as the fees:
usually paid [by tenants] on a pro rata basis, to compensate the landlord for the costs of operating, repairing, and maintaining common areas.
Well that’s a pretty good start, but let’s add one more category to possible CAM charges: anything the landlord and tenant agree to. And therein lies the danger to both parties.
While there are some generally accepted expense items (e.g., no one argues that snow removal of shared parking areas isn’t a legitimate CAM charge), and maybe an accepted principle or two (e.g., if an expense has virtually nothing to do with the operation, repair or maintenance of the property–like say, the landlord’s legal fees to set up an LLC to own the land–then that cost shouldn’t be passed on to tenants), but otherwise CAM charges simply are what the lease says they are.
And where a lease’s CAM sections are vague or poorly drafted, these common area maintenance charges can end up including many expenses tenants thought were out, or excluding many expenses landlords thought were in.
Why is this a big deal? Well, when a tenant’s CAM charges can potentially add up to more than their base rent, and when it is vital to most business to be able to project their expenses with some certainty, neither landlords nor tenants can afford vague or poorly drafted language.
To help avoid these kind of unpleasant surprises, this article explains the types of most expenses most often included in and excluded from CAM (and why each party thinks they should or shouldn’t), the importance of how calculate a tenant’s pro rata, how the risks of unanticipated charges can be shared (or shouldered by one party), and how tenants can confirm the costs ultimately paid represent the CAM charges they agreed to pay.
A tenant’s pro rata share is based on the square footage of the tenant’s use as compared to the square footage of the total property. Here is a math problem for the ages:
- If a shopping center has 100,000 square feet of leasable space, and
- A tenant occupies 4,000 square feet, then
- What is this tenant’s pro rata share of the center’s CAM charges?
I’ll wait while you think about it.
Did you say 4%?
Congratulations! You’re right! Or… you’re wrong. The answer is, read the lease and see how the parties agreed to calculate the tenant’s share. The variations are plentiful:
- Is the tenant’s square footage measured against the property’s total leasable area or only the currently leased space?
- If against currently leased space, how often is the percentage recalculated to reflect the square footages of new or vacating tenants?
- Does the tenant’s square footage include the total footprint of its premises, or is unusable space excluded? How about non-selling space (e.g., storage areas, or basements)?
- Are all tenants responsible for the same common area costs, or are there subsets of tenants who have to cover certain expenditures that only benefit them? (e.g., does everyone pay for utilities serving a common lunch room when only certain tenants can use it)
- Are large tenants (e.g., those exceeding 30,000 s.f.) excluded from the calculation?
- Are outparcels excluded?
You may end up at 4%, or you may not. But figure that out before you finalize that budget and sign that lease. Oh, and whatever method of calculation the parties agree on, they will generally want the right to confirm the actual footages before the dotted line has been inked.
What Kind of Expenses are Included in CAM Charges?
Notwithstanding the fact that CAM charges are entirely negotiable, they generally include only operating, repair and maintenance costs relating to a property’s common areas. The idea of course is that all tenants benefit from the upkeep of such areas, and so all tenants should contribute to the cost to do so. So, let’s look at operating expenses.
Typical examples of operational and maintenance costs include:
- Repair and maintenance of parking lots
- Snow removal
- Trash removal
- Janitorial and pest control services
- Real estate taxes
- Center signage
- Common area utilities
- Common area HVAC maintenance, and
- Landlord’s administrative fees
This last one, the landlord’s administrative fee, presents a couple of interesting points. First, because it’s typically assessed as percentage of the total CAM charges, a tenant may argue that some items should rightly be excluded from the calculation. For example, utilities. How much time can a landlord truly spend paying a utility bill? Yes, there are exceptions, but if the parties can agree the administrative costs are minimal for certain expenses (especially large expenses), and if the landlord really wants the tenant, such costs are sometimes excluded for the administrative fee calculation.
Secondly, what happens if a property owner hands over all of its duties to a third-party management company? Most tenants will agree they should share in the cost of the company’s management fee, but if this company is doing all of the landlord’s work, why should it pay any administrative fee at all? The answer? Whoever has the greatest leverage wins. That being said, worst-case scenario, the landlord will still charge its administrative fee, but not against the management fee.
Okay. Now it gets a little hairy… capital expenditures.
Capital expenditures (e.g., capital improvements, replacements and repairs) generally aren’t included in CAM charges. Tenants argue these costs are related to the owner’s investment in the property, are not a part of its operation, and thus shouldn’t be shouldered by tenants. The concept may be accepted, but there are exceptions, and there are difficulties in agreeing upon what is and what isn’t a capital expenditure.
First a couple of exceptions.
Some capital improvements not only benefit all tenants, but may also reduce the property’s operational costs, and thus reduce the tenants’ CAM charges. For example, where a landlord installs a better-functioning HVAC system, reducing the energy consumption needed to heat and cool common areas, tenants will see a reduction in their utilities CAM charge. So, landlords will argue it is in the best interests of the tenants to share the cost to make this upgrade.
Another class of capital improvement that tenants may reluctantly accept are those necessitated by changes out of the control of the property owner, including, for example, where a city changes its building code. A landlord may argue risks like these—those that benefit all and are the fault of none–should be borne collectively by its tenants. There is no right or wrong answer, only an agreement on who should bear the risk.
Nonetheless, whatever classes of capital improvements the parties agree should be a part of CAM charges, knowledgeable tenants often require two things:
- Where the improvement is discretionary, and its cost is going to be passed on to the tenants as a CAM charge, then the landlord can’t make the improvement without the tenant’s prior consent; and
- The cost of the improvement must be amortized over the useful life of the improvement.
In the absence of Number 1, a landlord may have an incentive to improve its property even where it only marginally benefits the current tenants. And in the absence of Number 2, a tenant could have to make a large upfront payment for an improvement that will last far beyond the tenant’s lease (and who leases a car for three years, knowing the car will be usable for ten, but still agrees to pay its full value on day one…).
As to capital replacements and repairs, tenants often assert such costs shouldn’t be included as a CAM charge because a landlord knows that systems benefiting the entire property will break, become obsolete, or just plain old wear down. This knowledge is reflected in a property’s acquisition costs, the depreciation the owner enjoys, and the rents it charges. To have a tenant pay for these replacements and repairs through its rent, and then again through a CAM charge seems (to tenants) unfair.
Landlords on the other hand may want to characterize the replacement or repair of these assets as part of the maintenance of the property. And maintenance costs should be a tenant’s costs. Additionally, as with a capital improvement, a landlord may argue that the replaced or repaired item will actually lower a facility’s operational costs (e.g., a fixed HVAC system uses less energy), and tenants should help with costs that are in their own best interest.
What should be taken from the above? Well, simply, while tenants and landlords may conceptually agree that CAM charges should only include operation, repair and maintenance charges, agreeing on what they are can be a much harder proposition.
Reconciliation (Audit and Adjustment)
Once the parties agree what expenses are included and excluded, the calculation of monthly CAM charges to a tenant is fairly straightforward. The landlord or its property manger projects the CAM expenses for the upcoming year, multiplies that amount by the tenant’s pro-rata percentage, and divides that number by twelve.
At the end of the year, the parties get to find out how accurate the projection was through an audit. If the projected budget was too high, and a tenant paid more than the actual expenses incurred that year, then it will get a credit towards its rent. If the budget was low, and accordingly tenant paid too little, then it’s check-writing time.
Integral to this determination is of course figuring out exactly what the actual costs were. In the absence of explicit language in the lease, a landlord might want to provide as little detail as possible. If a tenant really wants to confirm cost-accuracy, such summaries are of little value. Accordingly, savvy tenants will require that the lease give them the right to see invoices or other documents relating to each CAM charge.
Further, if a tenant has negotiated the right to such detailed statements, it should make sure it actually requests such detail each year. Where a tenant accepts simple, undocumented CAM statements for years, and then decides that one year it wants the detailed statement required under the lease, there is some chance the tenant will have waived their right to a detailed statement.
Lastly, all parties should pay attention to the lease’s audit notice requirements. If it says a tenant must request additional CAM charge detail within 30 days of receiving landlord’s initial audit materials, and the tenant doesn’t make this ask until Day 31, it may lose the right to challenge the accuracy of the charges.
Different CAM Structures
Not all landlords and tenants are alike. Some landlords have operated their property long enough that they know fairly well what their operating and maintenance costs will be. Some are just opening centers, and know that even their best guesses will be wrong. Some tenants prefer a set amount they can budget for, even if they know there will be some years where they pay more than the actual costs. Some would prefer the cost of auditing in exchange for possible savings. Some tolerate risk. Others none.
These differences result in different parties agreeing to different CAM structures. Let’s look at them.
Like its name suggests, in a fixed CAM structure the monthly amount is fixed. Because it doesn’t change over the lease term, there is no need to review the actual costs, i.e., where CAM charges are fixed, there is no year-end audit and adjustment. The benefits to both parties of this structure are that:
(1) They don’t incur the time and expense of an audit, and
(2) It makes budgeting easy.
This structure is typically only used where both parties have a history of operation, and thus a good idea of what their expenses should be. And where used, to reduce the risk the landlord will have to eat unexpected large expenses, they’ll generally estimate the costs on the high side. Tenants trade a little extra cost for a lot of certainty.
In some cases parties like the idea of a fixed CAM charge, but want some safeguards against one party dramatically paying too much or too little. So they tweak. For example, may have a periodic review of actual costs and make adjustments if there is a great disparity. Or, the parties may agree the fixed amount will only cover items under the landlord’s control. Any other costs (sometimes called “uncontrollable expenses”) will be shared by tenants according to the amount actually expended.
There is some fear by tenants that a landlord, where fixed CAM is used, will be more likely to reduce its operating expenses by cutting or reducing services. A periodic review may help alleviate this concern, but owners generally respond that such cuts will lessen the value of their property and the likelihood of attracting tenants.
Capped CAM Charges
Where tenants are leery about rising CAM charges, they often negotiate a cap, that is, a limit on the percentage CAM charges can increase each year. Such caps come in several different flavors, offering a cumulative or compounded rate, and calculated as year-over-base or year-over-year. Let’s check ‘em out.
Year-Over-Base Cumulative Cap
In a year-over-base cumulative cap, the annual increase in CAM expenses is limited by a fixed percentage of the projected first year expenses, and the percentage rate increases annually on a cumulative basis. For example, if the property manager projects the Year 1 charges as $ 10,000 and the agreed-upon percentage is 5%, then the cap on the tenant’s CAM charges for Year 1 will be $ 10,000 + ($ 10,000 x 5%), or $ 10,500.
This is the maximum amount of CAM charges the tenant will pay.
In Year 2 the $ 10,000 base remains the same (as it will through the lease term), but the percentage cap increases from 5% to 10%, meaning the most the tenant would pay in Year 2 CAM charges is $ 10,000 x 10%, or $ 11,000. And in Year 3, it increases to 15%, then 20%, and so on.
Like the fixed CAM model, this structure gives a tenant certainty as to its maximum charges.
Year-Over-Base Compounding Cap
In a year-over-base compounding cap, the first year base remains the same, but the cap percentage increases each year on a compounded basis.
Using the same numbers as above, the cap on tenant’s CAM charges is still $ 10,000 + ($ 10,000 x 5%), or $ 10,500. But in Year 2, the cap percentage increases to 5% + (5% of 5%), or 5.25%, and the cap amount becomes $ 10,000 x 10.25%, or $ 11,025. And Year 3 the percentage grows to 5.25% + (5.25% x 5%), or 5.5125%, etc.
While this structure has the same benefits to the parties as the year-over-base cumulative cap, it is more favorable to landlords because the cap percentage, and thus the maximum CAM charges, grows more quickly.
In year-over-year structures, the cap percentage is not applied to the base year amount, but rather the lesser of (i) the prior year’s actual expenses or (ii) the prior year’s cap.
Accordingly, in a year-over-year cumulative structure, using the same numbers above where the Year 1 cap was $ 10,500, if actual expenses totaled $ 9,000, then the Year 2 cap would be $ 9,000 x 10%. If, however, the actual Year 1 expenses totaled $ 12,000, then the Year 2 cap would be $ 10,500 x 10%.
This structure favors tenants because there is the possibility that actual expenses will be lower than that year’s cap amount, and those lower expenses will be the basis for the next year’s cap. The year-over-year cumulative structure works the same, except that the annual percentage rate grows on a compound basis.
One downside to the year-over-year calculations is that because they are tied to actual expenses, the parties must incur the time and cost of the audit process.
There really is no magic to CAM, but there is plenty of opportunity for surprises. When there was an unusually severe winter, the snow removal expense was ten times higher than the projected amount, and the 50,000 s.f. anchor with 500 parking spaces vanished after bankruptcy, how much does the coffee shop tenant owe? Look at the lease.
Did the tenant have a cap? Were uncontrollable events excluded from the cap? Was snow removal defined as an uncontrollable expense? Was the coffee shop’s pro rata percentage based on total leasable square footage or currently lease space? Was snow removal of the anchor’s parking to be shared amongst all the tenants? And what about next year’s CAM charges??
Well, certainly no magic, and with a lease that explicitly answers all of the above questions (and a whole bunch more), landlords and tenants can also keep the surprises to a minimum.
What was your worst CAM experience? Or if you have any comments or questions, go ahead and share them below!