True Confessions of a Landlord’s Counsel: What a Commercial Tenant Needs to Know When Negotiating a
Part 7: Additional Rent – Common Area Maintenance Costs.
Common Area Maintenance costs (generally known as “CAM”), should be one of the most negotiated areas of a commercial lease as so many factors and positions come into play which will vary according to the make-up of each commercial project. A tenant needs to be wary that its Landlord is not using CAM costs as potential profit center for the management, operation and maintenance of its commercial project. Likewise, a tenant will want to avoid paying CAM costs that are being used to improve the Landlord’s real property assets as opposed to just maintaining them.
Most landlord leases will provide that just about anything and everything associated with operating, managing and maintaining its commercial project falls under the CAM category. Some landlord leases will provide a page or two if items that are included in CAM. Most tenants correctly assume that such costs generally include maintaining the landscaping, fixing potholes in the parking areas, cleaning and maintaining common bathrooms and making sure the elevator works. Tenants may be surprised, however, to learn that in most landlord leases CAM will also include replacing the elevator or HVAC system for the building, replacing the roof, repaving the parking lot, painting the exterior of the building and the interior common area walls, and any other upgrades that landlord determines will improve the overall appearance of the project. Though tenants may rightly feel that most of these latter costs should be borne by the landlord as part of the base rent it is paying for its premises, and though there may be much merit to this position, many of these costs are thought as acceptable pass-through costs to the tenant and are typically found in most landlord leases, mostly because most tenants generally do not push back on these costs and landlords therefore get away with it. The exception to this rule is with retail tenants with multiple locations who become savvy to the ways of overreaching landlords. Such retail tenants may insert into their lease a page or two of items that are not to be included in CAM, such as holiday decorations for the project, marketing costs for the project, and landlord’s legal fees regarding other tenants.
It is therefore very important that the tenant and its broker request and carefully review landlord’s CAM costs for the project over the last few years, as well as what is projected for the current and next year for the project. If the tenant is moving into a new building and it has a relatively short-term lease, it may not be as concerned with overreaching CAM costs that passes on the costs of replacing major building systems. However, if the tenant is moving into an older building that has had significant maintenance issues over the last few years, and hopes to lease the premises beyond a 3-5 year term, that tenant may want to avoid paying a pro rata share for a new roof or a new HVAC system for the building that could occur during the last year of the tenant’s occupancy, and thereby not receive the full benefit of that passthrough CAM cost.
A tenant should resist being responsible for any “capital improvements” made to the building or project by the landlord. However, if the landlord insists it is the “going market” for the tenant to pay such costs, the tenant should at least get a guarantee from the landlord for a minimum amount of time for the current systems to be operable, and beyond that, the tenant should require that it only be responsible for its pro rata share of the cost of such improvement amortized over the useful life of the improvement. For example, if at the beginning of the fourth year of a five year term lease, the landlord replaces the roof of the building with a 20-year roof, the tenant should be only paying 1/20th of the pro rata share of the replacement of that roof for each year of the two remaining years of its term, as opposed to its pro rata share of the total cost of the roof in the fourth year of the term of its lease.
Tenants should also be skeptical about paying into “reserve funds” for the replacement of major systems such as a future roof (in lieu of a proration of the cost of the roof amortized over its useful life). Tenants should investigate how much money is in the reserve funds, be assured they are designated for only a particular improvement to be replaced, and what is the anticipated of time for the improvement to be made. The tenant, however should draw the line when it comes to making any improvements to a building’s façade, or any remodeling of common areas, as these are costs that are only improving the landlord’s asset to enable it to charge higher rents, so such costs should be borne by the landlord.
Some landlord leases will also try to “double dip” a tenant for the cost of managing and operating the commercial project. Landlords will charge a tenant a management fee based on one formula such as a percentage of tenant’s pro rata share of all the triple net charges under the lease, and then also charge the tenant a “an administration fee” which is based on some percentage of tenant’s base rent under the lease. In most cases only one or the other formula is used to charge a tenant its share for the management and administration of the project, with the percentage of triple net costs typically used in retail leasing and a percentage of rent being used in all other commercial leases (though the percentage of triple net costs have started to become popular in office and industrial leasing too). The tenant will need to rely on its broker to determine what is the local going rate for management fees. In retail leasing a large anchor tenant may agree to pay only 6 or 8 percent of what it considers “controllable” CAM costs, whereas a mom and pop inline shop tenant may be saddled with anywhere between 15 and 20 percent, without the “controllable” CAM costs limitation. Controllable costs are all costs that are “non-controllable”. Non-controllable CAM costs are those CAM costs over which the landlord has little control as to what these costs might be. These include real estate taxes, insurance premiums, and utility costs. As the landlord has little negotiating power to keep such costs low, it has not earned any management fee, and all it is doing is writing a check to the taxing authority, utility company or insurance company on these large line item expenses. Likewise, large tenants with leverage will also limit management fees on those maintenance costs that do not occur each year such as exterior painting and slurry coating the parking area.
Large tenants may also demand that any increase in CAM costs be limited from one year to the next (a “cap”), which cap may be anywhere from 2.5% to 5% (given that CPI on the average over the last 50 years has averaged about 3% each year). Such cap however is usually not applicable to the non-controllable costs mentioned above and allowed capital expenses.
A tenant and its broker should closely review any letter of intent provided by the landlord and read carefully any language regarding to CAM costs. A savvy landlord will include its draconian CAM costs language in the letter of intent to make it more difficult to negotiate the provisions out of the landlord’s standard commercial lease.