Address Four Issues in Fixed CAM Lease with Center Tenant

Traditionally, common area maintenance (CAM) costs are calculated based on an estimate of what a shopping center’s CAM costs will be for the year, and the tenant pays a proportionate share of those costs. At the end of the year, the tenant’s payments are reconciled with the center’s actual CAM costs.

That “pro-rata CAM cost system” seems straightforward enough, but although it’s the typical process for calculating costs, it has pitfalls. For example, it has the potential to lead to time-consuming disagreements over what items should or shouldn’t have been included in CAM costs and whether the CAM costs were accurately calculated and billed. And that can drag you into costly and time-consuming CAM cost audits.

There’s an alternative to estimated CAM costs, though. Consider switching from a pro-rata CAM cost system to a fixed CAM cost system. Of course, it’s not totally up to you. You’ll have to convince prospective tenants that fixed CAM is advantageous. Four issues commonly come up during negotiations for a fixed CAM lease. Here’s how you can address them—and Model Lease Language to use that’s advantageous to you and the tenant.

Discuss New System Basics

While paying fixed CAM costs may appeal to some prospective tenants, others may have concerns with it and resist signing a fixed CAM lease. “You can persuade resistant prospective tenants to sign your fixed CAM leases if you’re prepared with good arguments to overcome their concerns,” says Mark A. Arbus, associate general counsel of General Growth Properties, a real estate investment trust focused exclusively on owning, managing, leasing, and redeveloping regional malls.

Explain to the tenant that, with a fixed CAM cost system, it’ll agree to pay a flat, predetermined amount each month towards the center’s CAM costs. Since the CAM payments are fixed, there’s no need for an end-of-the-year reconciliation of the tenant’s estimated CAM payments and the center’s actual CAM costs to determine whether the tenant underpaid or overpaid its share of CAM costs. You can point out that, by eliminating the estimated payments and end-of-the-year reconciliations, this system saves the tenant time. (And, in your favor, audits that can result from them are also eliminated.)

Let the tenant know the benefits that fixed CAM costs offer to it. With a fixed CAM payment, a tenant knows exactly what its CAM payment will be in every year of the lease, notes Arbus. This eliminates the unknown, unexpected costs that can pop up under a pro-rata CAM system and wreak havoc on a tenant’s cash flow. And since the tenant knows what its CAM payments will be, its budgeting process becomes much simpler, he points out.

Prepare for Common Concerns

Despite the benefits that a fixed CAM cost system offers, reluctant prospective tenants might have issues with the calculation of the fixed CAM costs, as well as what may happen during the life of the lease. How should you respond?

Issue #1: Without audit, tenant can’t negotiate reasonable fixed CAM. A tenant may not want to sign a fixed CAM lease until you let it audit your books and records. It may claim that it can negotiate a reasonable fixed CAM payment with reasonable increases only after it verifies your center’s actual CAM costs.

Explain to the tenant that the only issue that matters in evaluating the fixed CAM amount is whether the overall economics of the deal work for the tenant, says Arbus. If the fixed CAM number works within the context of the entire financial deal, then knowing the previous actual CAM costs, down to the penny, is irrelevant for the tenant, he notes. An audit isn’t necessary.

Issue #2: Fixed CAM leads to deterioration of services. A tenant may worry that a fixed CAM cost system could lead to a deterioration of CAM services—such as maintenance and repairs. The tenant may reason that if your reimbursement is fixed and your costs rise, you’ve got no incentive to properly maintain the center.

Tell the tenant that you have no desire, nor would it be smart from a business perspective, to let your center deteriorate, says Arbus. Also point out that if, as is usually the case, you’re using your center as collateral for a mortgage loan, it’s likely that the loan documents will require you to be in compliance with laws and/or maintain the center or risk being in default. And remind the tenant that because of the competitive nature of the retail marketplace, you have to keep your center in excellent condition and run it efficiently to attract and hang on to desirable tenants, he says.

You can also offer to include lease language to allay the tenant’s fears, Arbus notes. One measure is to promise to maintain the center’s common areas in a manner consistent with first-class shopping centers of a similar size and nature. To set up this compromise, add the following language to the lease:

Model Lease Language

Landlord shall, subject to events beyond its reasonable control, maintain or cause to be maintained the Common Areas in good order and repair in a manner consistent with first-class shopping centers of similar size and nature.

Issue #3: Exclusions undermine fixed CAM. A tenant may worry that you’ll try to exclude certain “uncontrollable” costs from the fixed CAM cost system. Those costs could include snow removal costs, insurance costs, utility costs, and so-called “extraordinary expenses.” You may plan to charge those costs to the tenant over and above its fixed CAM payment to avoid getting burned if the costs spike. But the tenant will argue that once you start making these exclusions, the fixed CAM cost system begins to look like pro-rata CAM and the tenant will no longer have certainty about its costs.

One option is to agree not to exclude uncontrollable costs from fixed CAM, advises Arbus. Alternatively, if you want to exclude those costs but the tenant objects, you could agree to set a cap on the excluded uncontrollable costs, so that the tenant isn’t taking such a big financial risk, he adds. To set such a cap, add the following language to the lease after it discusses fixed CAM costs:

     Model Lease Language

     a. In addition to Tenant’s obligations under Clause [insert # of the fixed CAM cost clause] hereof, Tenant shall pay Tenant’s share of any “Uncontrollable Expenses” (as hereinafter defined); provided, however, that in no event shall the amount of the Uncontrollable Expenses, in the aggregate, exceed [insert $ amount or method of setting cap].

     b. “Uncontrollable Expenses” shall mean those Expenses that, in Landlord’s sole discretion and judgment, may be subject to increases which are outside Landlord’s control. Uncontrollable Expenses shall include, but not be limited to, any Expenses relating to:

     (i) Insurance;

     (ii) Utilities;

     (iii) Collectively bargained union wages;

     (iv) Real estate taxes;

     (v) Snow removal costs; and

     (vi) Any other extraordinary expenses.

Issue #4: Escalator results in excessive CAM increase. An annual fixed CAM payment will increase each year by a set rate—known as an “escalator.” A prospective tenant may express concern that a set annual escalator like this will hit it too hard financially. It may point out that while the percentage may seem small, it would become unfairly high over time, as it compounds annually.

Example: The first year of fixed CAM is $20 per square foot. Fixed CAM is increased by a 5 percent compounded increase over 10 years. In the 10th year, the tenant will pay fixed CAM of over $31 per square foot—that’s an increase of 55 percent over the 10-year lease.

If the tenant argues that the percentage should be lower or tied to the Consumer Price Index, how should you respond? Here too, point out to the tenant that its bottom line should be whether the fixed CAM economics make sense for it in terms of the entire deal, Arbus says. Remind the tenant that you’re assuming all of the risk if actual CAM costs spike above the escalator percentage, which they may do even with the compounded increases, Arbus notes. For instance, there’s no assurance that under a pro-rata system, the tenant in the example above would be paying less than $31 per square foot in the 10th year, he says. It could be paying more, he adds. Plus, even with compounded increases, the tenant has certainty about its fixed CAM payments.

Insider Source

Mark A. Arbus, Esq.: Associate General Counsel, General Growth Properties, Inc., 110 N. Wacker Dr., Chicago, IL 60606; www.ggp.com.