San Diego Business Lawyer Blog
Common Area Expenses (or CAM expenses) are nothing new in the commercial leasing business. However, new business owners are often caught off guard by the thought of the additional expense that sometimes is as high as the base rent itself, especially where there is so little control over how the expenses are managed. Leases that require tenants to pay common area expenses (including property taxes and insurance) are called triple net leases. It is common these days for landlords to pass on every imaginable expense to its tenants. So long as the landlord is passing on legitimate expenses that are necessary for the operation and maintenance of the common areas, there is nothing inherently wrong with the practice. However, prospective tenants should work closely with their attorney to carefully review the proposed lease terms to ensure they have a complete picture of the potential liability and that the landlord isn’t using the CAM charges as an additional source of revenue. Ideally, tenants will negotiate for a gross lease that is inclusive of all landlord expenses. However, in most cases negotiating for a gross lease is difficult (if not impossible). Where a net lease is your only option, the following is a list of important considerations:
Pro Rata Share: A tenant’s pro rata share of common area expenses should be determined based on the tenant’s leased square footage compared to the commercial property’s gross leasable space, not “leased” space. In other words, the pro rata share is determined based on 100% occupancy. Landlords often seek to defer costs associated with empty space and will try and include lease language that calls for CAM charges to be calculated based on the square footage of “leased” space rather than “leasable” space. Tenants should seek to amend such language so that the landlord absorbs the expenses associated with empty space.
Audit Rights: Tenants should try and negotiate for the right, upon reasonable notice, to audit the landlord’s accounting records. Such clauses are common in commercial leases and allow tenants to ensure that the common area expenses are calculated correctly. Look closely at the lease language as these clauses typically set forth specific procedures for examination of records and for resolution of disputes. Sometimes leases limit the frequency of tenant audits. The more often you are allowed to audit, the better. At the very least, tenants should have the right to audit accounting records once a year within six months of reconciliation (the time landlords reconcile actual expenses with estimated expenses).
Management Fees: Management fees are common, especially in the retail setting. The practice is prevalent and prospective tenants should ensure that the lease clearly defines what the management fees are and how they will be calculated. Management fees should not exceed three percent of the property’s gross receipts, and shouldn’t include expenses for off-site personnel and overhead. In some cases, landlords seek both administrative and management fees. While this may be appropriate in some circumstances (i.e. landlord hires a separate management company to manage the property), it’s important to clearly understand exactly how these fees are delineated and to make sure that the landlord isn’t double dipping. Try and negotiate for limits on management fees.
Clearly Defined Expenses: Ensure that the common area expenses are clearly defined in the lease. Vague and ambiguous language that doesn’t spell out precisely what expenses will be included in CAMs leave tenants open to excess costs.
Exclusions: In addition to clearly defined CAM expenses, your lease should clearly set forth exclusions. The list of common exclusions is extensive. A prospective tenant’s ability to negotiate for these exclusions depends of course on the tenant’s bargaining power. The key is to be aware of these potential exclusions and bargain for those that are most important. At the very least, charitable donations, expenses relating to other tenants exclusively, landlord’s capital expenditures, proposition 13 taxes, and other tax compliance expenses are exclusions prospective tenants should try and negotiate for.
Property Tax Assessments: Where property taxes are included as common area expenses, tenants should seek a provision requiring the landlord to cooperate with tenant in timely appealing tax assessments.
Common Area Expense Caps: As with everything in contract negotiation, the ability to negotiate for a cap on CAM expenses depends on the tenant’s bargaining power. Nonetheless, prospective tenants should at least try. You may also be able to put a maximum on the annual CAM increases.
To get a better handle on what the CAM expenses will look like moving forward, ask to review the property’s CAM history. When crunching the numbers be sure to clearly understand what your total monthly outgo will be including base rent, CAM expenses and your insurance requirements.