Don’t Get Stuck with Unexpected Insurance Costs

Your shopping center leases probably require each tenant to pay its share of the center’s fire insurance, liability insurance, and other kinds of insurance. However, if you want to pass through your insurance costs to your tenants as a separate component of common area maintenance (CAM) costs solely by using a standard formula based on “gross leasable area,” it could leave you on the hook for costs you thought would be paid by your tenants. That’s because, if your leases base each tenant’s share of your insurance costs on a percentage of the center’s gross leasable area, but your anchor tenants carry their own insurance, you won’t get reimbursed in full for your insurance costs. You can protect yourself from this financial pitfall, though, by properly calculating each tenant’s share of your insurance costs so you aren’t stuck footing the bill for the shortfall.

So avoid using a standard formula. A common formula based on gross leasable area (GLA) to determine the tenant’s share of insurance costs looks like this: Owner’s insurance cost x (tenant’s area ÷ GLA).

Example: Your center has a GLA of 100,000 square feet. You pay $50,000 for insurance on the buildings in your center. Half of the GLA is occupied by a 50,000 square-foot anchor tenant supermarket. Occupying the remaining 50,000 square feet are a 20,000 square-foot drugstore and three small 10,000 square-foot stores. Under the standard formula, you would figure the annual contribution for each of the four nonanchor tenants in these five steps:

Step #1: Calculate the drugstore’s share: $50,000 insurance cost x (20,000 sq. ft. ÷ 100,000 sq. ft.) = $10,000;

Step #2: Calculate the smaller stores’ share: $50,000 insurance cost x (10,000 sq. ft. ÷ 100,000 sq. ft.) x 3 (number of 10,000 square-foot stores) = $15,000;

Step #3: Add the results of steps #1 and #2 together: The four nonanchor tenants would contribute $25,000 ($10,000 from the drugstore and $15,000 from the three smaller stores);

Step #4: Calculate the anchor tenant’s share: $50,000 insurance cost x (50,000 sq. ft. ÷ 100,000 sq. ft.) = $25,000; and

Step #5: Add the results of steps #3 and #4 together: The five tenants would contribute a total of $50,000 ($25,000 + $25,000), which covers your entire insurance cost.

But there’s a problem with those calculations: In reality, all five tenants may not contribute.

That’s because tenants with insurance complicate matters. Anchor tenants and tenants such as free-standing, fast-food restaurants usually have their own insurance policies. These policies cover all the properties at which the tenant operates. It’s more cost-effective for those tenants to include their portion of the center under their own coverage, rather than get coverage under your policy. But look at what happens to the prior example if the anchor tenant provides its own insurance: The remaining four tenants’ contribution of $25,000 will cover only half of your insurance costs. You’ll have to make up the difference until you can get a new insurance policy. Even so, a new policy won’t make up for the shortfall in the other tenants’ contribution.

Splitting your insurance premium into two parts can protect your interests if you have at least one tenant with its own insurance. When you split your insurance premium into two parts, make sure that all new nonanchor tenants at the center are required to pay the center’s insurance premiums in two parts.

For an explanation of how to split your insurance premium, and Model Language that you can use in your leases, see “How to Ensure Tenants Will Pay Your Entire Insurance Cost,” available to subscribers here.