How to Negotiate Common Area Costs (CAM) in Commercial Leases
Tenant Tip Series
By Clint Wilson
Tenant Tip Series is a series of different tips provided by Baker Burton & Lundy for commercial tenants to consider while negotiating retail leases, restaurant leases, commercial leases or industrial leases. This series will regularly address a variety of important tenant-oriented issues that arise during lease negotiations.
Today’s tip identifies different strategies that any tenant in a multi-tenant project or shopping center should utilize during lease negotiations to gain some cost control measures over Additional Rent. “Additional Rent” is the amount a tenant is obligated to pay under the lease in addition to the base rent and includes the amorphous “common area costs” (also commonly known as “CAM Costs,” “Operating Costs” and “Operating Expenses”). A tenant in a multi-tenant project or shopping center will generally be obligated to reimburse the landlord for its pro rata share of such expenses, which are usually broadly defined to include any and all costs the landlord incurs for real estate taxes, and in maintaining, repairing, replacing, improving, insuring and managing the project or shopping center.
The Issue With Common Area Costs (CAM)
Since common area costs and the increases thereof are generally not fixed or even capped, they often outpace the annual increases in base rent. Additionally, landlord-oriented leases will include few or no limits on the type of and amount of charges the landlord includes as common area costs, thereby enabling the less scrupulous landlord to use common area costs as a means of profiting from such charges. It’s worth emphasizing that the purpose of common area costs is to reimburse the landlord for legitimate expenses associated with the project or shopping center (and specifically the common areas) and not to provide the landlord with the opportunity to profit from such charges. With that said, there are many charges and expenses that should either be excluded from the definition of common area costs or capped to ensure that tenants are paying only their fair share of such costs.
As an example, most leases provide that the landlord can charge the tenant for a management fee for the landlord or some third-party company to manage the project or the shopping center. Without a cap on the amount the landlord can charge as a management fee, the landlord could charge a reasonable management fee or an exorbitant management fee for the landlord’s cousin to manage the project or shopping center. The landlord might also charge a separate administration and supervision fee in addition to the management fee. We have seen these fees as high as 30% of the common area costs, which is an indicator that the landlord is using common area costs to generate additional income. As such, the importance of negotiating certain cost control measures over common area costs becomes paramount in controlling the amount the tenant pays in additional rent.
There are also various other charges and expenses that should be excluded from common area costs which are usually included by the landlords with more favorable leases, including capital expenditures, attorneys’ fees, damages caused by the acts of landlord, etc. In order to make sure that the tenant is paying for legitimate common area costs, here are few suggestions.
Steps To Reducing Common Area Costs (CAM)
1. Establish a First Year Cap on CAM Costs
First, the tenant should start by asking the landlord for a budget of what common area costs are projected to be for the first calendar year during the lease term. A good starting position would be to then ask for a first year cap on common area costs based on the projected common area costs set forth in the budget. If the landlord rejects this proposal, then the tenant can propose that the projected common area costs plus 5% should serve as the first year cap, which will provide the landlord with some flexibility if the actual common area costs are more than what was projected in the budget. Also, getting a budget of common area costs will provide the tenant with insight as to what expenses and charges the landlord intends to include in common area costs. This is helpful in identifying any expenses and charges that should be excluded from common area costs, as further discussed below.
2. Set an Ongoing Cap on CAM Costs
Along with the first year cap, the tenant should also request an ongoing cap on common area costs so that such costs cannot increase year-over-year in excess of some percent (e.g., 5%). An ongoing cap will provide the tenant with a much clearer picture of what common area costs (and additional rent) will be in the future. Being better able to forecast future expenses is beneficial to any tenant. It’s worth noting that certain items of common area costs are generally excluded from ongoing caps, including real estate taxes and insurance costs.
3. Negotiate the Exclusions from CAM Costs
The tenant should also provide the landlord with a list of items that should be excluded from common area costs, such as mortgage payments, capital expenditures and management fees in excess of some percent of common area costs, etc. This ensures that the landlord is not using common area costs to generate profits but to actually cover legitimate expenses relating to the common areas of the project or shopping Center. We typically negotiate on behalf of our client-tenants an extensive list of expenses that are excluded from common area costs.
4. Include an Audit Right
Lastly, the tenant should always negotiate for an audit right (i.e., the right to review the landlord’s books and records relating to common area costs) to keep the landlord honest. If the tenant elects to have an audit performed and the results show that the tenant overpaid for common area costs during the applicable year, then the landlord should then reimburse the tenant the overpayment amount or credit such amounts from the next installment of rent.
Final Thoughts on CAM Cost Control
These are just a few cost control measures that can assist the tenant with controlling and reducing its common area costs and Additional Rent. Over the term of the lease, which might be 5 to 20 years, this can equate to considerable savings to the tenant. Obviously, negotiating to include these measures depends on many factors, including the leverage either party possesses in the negotiation and what is considered customary at that time in that market. If you need assistance in the negotiation process, please reach out to an attorney experienced in commercial lease negotiations.
Please Note: This document does not constitute legal advice. Please consult an attorney for legal advice on what to do in a particular situation.