BlogLease AccountingThe Importance and Financial Impact of CAM Clauses in Your Commercial Lease

The Importance and Financial Impact of CAM Clauses in Your Commercial Lease

The difference between a clearly vs poorly written Common Area Maintenance (“CAM”) clause can cost you

You’re a retailer who has just signed a lease for the absolute best real estate transaction in town– the agreed-upon rents are unbelievably amazing, along with the additional charges for marketing, real estate taxes, and insurance.  The total amount is in line with your budget so that after your first year in business, you’re forecasting enough increase in your net operating income (NOI) that you will be able to take that long-awaited vacation to Tahiti! Oh, and there’s that CAM charge that you don’t completely understand, but seems reasonable.

Now, not to burst your “Tahiti” bubble and all, but without a well-negotiated and clearly written CAM clause, you are taking a significant big financial risk. This could involve potentially being obligated to pay the landlord unexpectedly higher CAM charges to the landlord, as well as along with continual ongoing increases of those charges during your entire lease term. So, listen up!

What are CAM Charges in a Lease?

Common Area Maintenance charges, or CAM charges, are costs (controllable and uncontrollable) that landlords incur for the management, maintenance and repair of common areas at a shopping center. CAM charges can also be referred to as “operating expenses,” and are sometimes passed through to the various tenants at the shopping center.    

They may sound simple, but this is one of the most misunderstood clauses in a retail lease, and if poorly written, can have one of the biggest unforeseen monetary impacts on a retailer’s NOI. 
Think of it this way: Have you ever found the best offer on earth when shopping online?  You rush to click ‘buy now’ before that limited number of low-cost items run out?  (With all the money you will be saving, you are already thinking of going to Tahiti with your retailer friend.)  When your fancy vegetable chopper arrives the next day, you’re so thrilled and proud of yourself for finding such a great deal.  

Oh, but wait…. later you open your credit card statement to find that the minimal charged amount is not so minimal after all.  The total amount includes all kinds of unexpected costs and fees.  From a shipping fee to a handling fee to a restocking fee, plus an automatic continuous monthly subscription cost because, guess what … you get a brand NEW kitchen gadget every month for the next 12 months!  (Okay, getting carried away here, but you get the point!)  

Maybe, just maybe, if that online description and offer had been written clearly vs. poorly, you would have been better informed.  Today you would not have all those chopped carrots in your freezer taking up space, and a growing pile of new kitchen gadgets on your kitchen countertop. Not to mention that you would certainly have more money in your bank account!

In the same vein, a vague or poorly written CAM clause can have major negative unforeseen monetary implications for a retail tenant.

In order to stay ahead of any unnecessary CAM charges, there are four important steps you should take: 
(1) Clearly define “excluded” costs the landlord will not be allowed to pass through
(2) Understand how the CAM costs are allocated and how pro-rata share is calculated
(3) Negotiate a cap or limit on the annual increases of CAM charges
(4) Request and obtain audit rights  

We’ll dive into the details of each of those below.

Tip 1: Clearly Define What is Excluded from CAM Costs

While retailers and landlords may agree that CAM charges include direct costs for management, maintenance, and repair of common areas, having both parties agree on what they should and should not include can be a challenge.  If the lease language lacks clarity in defining what expenses are included in the CAM calculations and what expenses are specifically excluded, it leaves room for unexpected or excessive CAM charges to be passed through to the tenant. 
There is no clear-cut industry standard definition of what particular CAM charges should be included. Therefore, a retail tenant should carefully review the list of the CAM costs that the landlord is proposing to pass through and begin to negotiate some of those items out. 

The following is a partial list of ordinary CAM costs that a retailer should ask its landlord to exclude:

  • Capital expenditures of any kind
  • Any costs related to maintenance, repair, or replacement of any structural component of the shopping center
  • Expenses related to foundation issues
  • Any expenses related to repairs of roof structure
  • Any ownership related costs (i.e. costs that do not benefit the tenant, such as charges for depreciation, mortgage interest, debt service or financing fees)
  • Legal fees, leasing commissions, and professional fees incurred by the landlord from negotiating other leases or resolving disputes
  • Costs to the landlord for renovating, improving, decorating, or painting vacant space for other tenants
  • Costs incurred by the negligent acts of the landlord
  • Costs or expenses which are covered by insurance the landlord is required to maintain

Tip 2: Understand how the CAM Costs and Pro-Rata Share is Calculated

A tenant’s pro-rata share provision is a common method for cost allocation, but beware of how the lease language is written, because it can increase the tenant’s liability of costs by directly affecting the math, and subsequently the outcome of its pro-rata share formula. Below are a few examples of basic formulas for determining the tenant’s percentage of its pro-rata share and calculating the tenant’s annual CAM charge. Each scenario is based on how the lease language is written:

Scenario “A” – based on actual size (Gross Leasable Area “GLA”) of the shopping center and estimated expenses (without consideration of any exclusions) the landlord is allowed to pass through to the tenant:

Step 1 (Tenant’s pro-rata %):
SF of tenant’s demised premises/SF of the shopping center = tenant’s pro-rata share of CAM charges
Example:  4,000 sf/100,000 sf = 4% (tenant’s pro-rata share)

Step 2 (Tenant’s CAM charge): 
Tenant’s pro-rata share x landlord’s estimated annual CAM expenses = tenant’s annual CAM charge 
4% x $1,200,000 = $48,000/annually

Here comes the fun part of understanding the impact of lease language on the outcome of the above formulas, and whether you can actually take that fabulous Tahiti vacation or simply afford to sit at your kitchen counter chopping veggies while drinking a tropical beverage  with a little paper umbrella peeking out!  

In Scenario A(step 1 above) the percentage of the tenant’s share of 4% assumes the shopping center square footage is based on the actual Gross Leasable Area (“GLA”) of 100,000 sf.  

However, if you look at Scenario B below, and base it on lease language defining the shopping center square footage “for pro-rata share purposes” as Gross Leased and Occupied Area (“GLOA”), the tenant’s share goes up to 5% and its CAM charge increases from $48,000 to $60,000.  OUCH!  That’s because based on GLOA, if, at the commencement of the lease, the shopping center is only 80% leased and occupied and 20% vacant. That 100,000 sf becomes 80,000 sf, causing the higher calculation in the tenant’s percentage share. (Caveat: There can be more than one definition for square footage in a lease depending on what that square footage is going to be used for – in this example GLOA for pro-rata purposes.)

Scenario “B” – based on lease language defining the shopping center square footage for pro-rata purposes as the Gross Leased and Occupied Area (“GLOA”)  

Step 1 (Tenant’s pro-rata %): 
SF of tenant’s demised premises/SF of the shopping center = tenant’s pro-rata share of CAM charges

Example:  4,000 sf/80,000 sf = 5% (tenant’s pro-rata share)

Step 2 (Tenant’s CAM charge): 
Tenant’s pro-rata % x landlord’s estimated annual CAM expenses = Tenant’s annual CAM charge

5% x $1,200,000 = $60,000/annually

Taking this same example further, unless the retailer negotiated specific exclusions for some of the pass-through expenses, the landlord may have included in that sum of $1,200,000 for the shopping center’s estimated annual CAM expenses in Scenarios A and B (Step 2), (i) a $30,000 cost for the landlord to renovate a vacant space, plus (ii) a $55,000 expense to repair a foundation crack, for a total of $85,000. 

If language had been agreed to by both parties and drafted to exclude the costs of those two items (renovation to other vacant spaces and foundation repairs), the $1,200,000 estimated shopping center annual CAM expense would have been reduced by subtracting $85,000. This makes  the total CAM expenses allowed to be passed through to the tenant to equal $1,115,000.  
Let’s see what Steps 1 and 2 look like now assuming the lease language set forth a definition for pro-rata share based on GLA vs GLOA, and the landlord agreed to exclude certain pass-throughs like the two mentioned totaling $85,000.

Scenario “C” – based on lease language defining square footage for the shopping center as GLA for pro-rata purposes, and additional language excluding the landlord from passing through (i) expenses for renovations to other vacant spaces and (ii) cost of repairs due to foundation issues.

Step 1 (Tenant’s pro-rata %): SF of tenant’s demised premises/SF of the shopping center = tenant’s pro-rata share of CAM charges
Example:  4,000 sf/100,000 sf = 4% (tenant’s pro-rata share)

Step 2 (Tenant’s CAM charge): 
Tenant’s pro-rata % x landlord’s estimated annual CAM expenses = Tenant’s annual CAM charge

4% x $1,115,000 = $44,600/annually

Bottom line, if a retailer agrees to a pro-rata share allocation for CAM charges, it is critical for the retailer to understand its lease language when calculating its pro-rata share percentage and to have a clear picture of what landlord expenses can and cannot be passed through.  One of the biggest pitfalls for a retailer is thinking a formula looks straightforward and easy to calculate without considering how the written lease language can affect the outcome of the equation.  The above scenarios are a “bare bones” simplified glimpse of the many possible variations of calculating pro-rata share and CAM charges. 

Tip 3: Negotiate a cap or limit on the annual increases of CAM charges

There are a few ways for a retailer to have more control over not getting hit with a “surprise amount” (i.e., more than the tenant was expecting) increase each year. These can include:  (1) negotiating a cap (or limit) on the amount of increase each year, or (2) negotiating a “fixed” CAM charge with a set annual increase, or (3) agreeing to a “gross” or “modified gross” lease.   Any three of these will help a tenant budget more accurately for the term of its lease. We’ll outline the differences below: 

Cap (or limit) on pro-rata share method:
The often-challenging and costly disputes between the tenant and the landlord regarding  the intended interpretation of the lease language concerning CAM costs are less frequent if a retailer negotiates an agreed-upon amount for its first year’s CAM costs and then caps the following annual increases.  Two specific lease language terms  are extremely important when setting a cap on annual increases – “non-cumulative” vs “cumulative.”  

Non-cumulative cap: 
A retailer will always want to strive for a “non-cumulative” cap.  This type of cap sets a maximum limit on the annual CAM expense increases and does not allow the landlord to recover any unused increases from previous years. For example, if the agreed-upon non-cumulative cap is 5% on annual increases, and the first year the landlord’s actual expenses increase by 7% (maybe a harsh winter that year and the landlord spent more on snow removal), the tenant is only obligated to pay up to a 5% increase. In addition, if the following year the landlord’s actual expenses only increase by 3%, then the tenant is only obligated to pay a 3% increase. 

Cumulative cap: 
A “cumulative cap” on annual increases over the lease term means that if the tenant’s actual share of CAM cost increase in one year exceeds the cap, the excess amount effectively “rolls over” to future years.  Using the “non-cumulative” example above, the tenant would still pay only a 5% increase in year one (because it’s capped at 5%) although the landlord’s expenses increased by 7%. On the flip side, the following year when the landlord’s expenses increased by only 3%, the tenant would not only have the advantage of  paying the 3% increase as it did above, but instead would be obligated to pay its full cap of 5%. This is because the landlord was able to roll over that extra 2% from the previous year.  (Say, do you need a pencil and paper for this?)

Fixed CAM charges: 
In a fixed CAM structure, the monthly amount is fixed and increases at a fixed rate over the lease term no matter how much the landlord’s expenses fluctuate year after year. The upside for a retailer is that this method makes it easier to budget and alleviates the time and expense of an audit.  The downside, however, is important to note:  with this method, the tenant will need to be aware of what landlord expenses are truly “fixed.”  The two major categories are “controllable expenses” and “uncontrollable expenses.” 

Gross or modified gross lease:
Another way for a retailer to limit its exposure to unanticipated higher increases in CAM charges is to ask if the landlord will agree to a “gross” or “modified gross” lease.  Different from a NNN lease (where rent, taxes, CAM and insurance are all separate amounts), a gross lease or modified gross lease includes the CAM charges in the tenant’s base rent.  Of course, base rent will be higher; however, the amount is set therefore taking the guesswork out of budget forecasting.

Tip 4: Always insist on audit rights

A retailer’s lease should include rights to review and audit the landlord’s books and records to verify the validity of CAM costs charged and the information used in the formula to calculate the tenant’s pro-rata share by the landlord.  The audit clause will allow the retailer to uncover any overcharges by the landlord,  potential errors, or  discrepancies in how its pro-rata share was calculated. This can arise from differences in interpreting the written lease language. Any number of errors or misinterpretations can be uncovered in an audit.  A couple of business points to consider when drafting the audit language is:

Window of opportunity to audit:
Once the retail tenant receives the landlord’s end-of-year reconciliation of CAM charges reflecting any additional money owed, there is typically a limited time in which the tenant can request an audit to dispute any charges.  Pay close attention to that “window of opportunity,” because if it is too small, the tenant could miss its chance to review the landlord’s books and records.  For example, if the landlord only provides  the tenant 30 days after receiving  the  year-end statement to request an audit, then on the 31st day, if the tenant has not responded, it is highly probable that  the landlord will consider it  accepted by the tenant, leaving the tenant with no further recourse.

Restrictions by the landlord on what documents can be reviewed and audited:
Beware of only having access to the landlord’s “summary” of charges vs. actual documents.  To truly confirm the accuracy of the landlord’s CAM charges, the tenant will want its audit clause to give it a right to review invoices and other documents relating to each specific CAM charge.

Pack Your Bags, you’re going to Tahiti!

In conclusion, CAM charges can make up a significant portion of a retailer’s monthly expenses and be challenging  to accurately budget and forecast.  However, proper care and knowledge in negotiating what can and cannot be included in CAM costs, clearly writing lease language,  understanding the tenant’s pro-rata share calculation, having more control over exposure to how much annual increases are allowed, and obtaining audit rights are vital to controlling and forecasting CAM costs.  See you in Tahiti!

Have other lease questions?

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