Demystifying the Commercial Lease: Common Area Maintenance Charges

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All musicians must maintain their instruments. String instruments can be especially expensive to maintain. If the musician plays regularly, their instrument may need new strings several times a year at a cost ranging from $50 to mid-price violin strings to $275 for high-end cello strings. Bow hair also needs to be replaced just as frequently, at $75 or more per rehair.

String instruments are made from dozens of different pieces of wood, carefully carved and glued together. Fine instruments are glued together with water soluble glue made from animal skin and tendon. This water-soluble glue makes it more likely that the glued seams will open when stressed, instead of the wood itself cracking. Serious musicians carefully monitor humidity levels in their instrument cases. Still, string instruments sometimes develop cracks or seams may come unglued and need repair.

Weather, particularly humidity, changes also can necessitate regular string instrument adjustments. Some musicians have different bridges (the piece of wood that holds up the strings) or sound posts (a wooden dowel inside of the instrument that resonates to create sound) for summer and winter. Even most professional musicians do not make these adjustments themselves.

Regardless of what the instrument dealer says, the musician always pays for instrument repair and maintenance. Sometimes, the musician pays directly, but other times, the cost is buried in a purchase or rental fee.

For instance, when a parent rents a string instrument package for their child, the rental rate may include repair and maintenance. In those cases, the cost of the repair and maintenance may not be an itemized charge but is buried in the lump-sum monthly rental fee. Other times, parents can purchase a maintenance and repair package. These packages usually include regular string replacement and bow rehairs plus a discount on more comprehensive repairs and maintenance.

Like musicians, real estate owners must repair and maintain their properties to keep them in good condition. And like musicians, real estate tenants always pay for that repair and maintenance. In a building where tenants share use of some of the space, such as parking lot, elevators, or lobby, building maintenance costs either will be buried in the monthly rent charge, will be billed separately by the landlord, or a combination of the two.

This article is one in a series about “Demystifying the Commercial Lease.” This article discusses common area maintenance (CAM) charges in leases.

What Leases Include Common Area Maintenance (CAM) Charges?

When a tenant leases less than the entire commercial building, they usually have a full service, modified gross, or double net lease. Under those leases, tenants must pay the landlord for common area maintenance (CAM) charges in addition to the base rent.

CAM charges the costs of running the “common areas” or shared areas of the building. These charges might include things like utilities, cleaning maintenance, taxes, and insurance. Because the tenants all benefit from the common areas, landlords allocate CAM charges among the tenants based upon their prorata portions of the building’s rental space.

Most landlords charge a monthly, estimated CAM amount on top of base rent. At the end of the year, if the estimate was low, the tenant will receive a bill for an additional payment. If the estimate is high, tenants usually receive a credit.

Key Terminology

To understand how landlords calculate CAM, it’s helpful to understand basic terminology:

Common Area

The common area is the part of the building used by more than one tenant. This usually includes lobbies, elevators, and stairways, parking lots, hallways, landscaping, sidewalks, and bathrooms, not inside an individual tenant’s space. If a building has a fitness area, vending area, or similar space open to multiple tenants, it also would be part of the common area.

Pro Rata Percentage

Tenants pay for building CAM based upon their “pro rata percentage,” which is the percentage of the rentable part of the building they occupy.

Base Year

Most leases initially establish the rental rate, so some CAM charges are included in the base rent. The year used to calculate the CAM charges included in the base rent is called the “Base Year.” The tenant only pays for CAM charges above those for the Base Year.

Uncontrollable Expenses

Uncontrollable expenses are operating expenses that the landlord cannot easily adjust or influence. Taxes, insurance, and utilities usually are considered uncontrollable expenses. In some locales, snow removal also is considered an uncontrollable expense.

Controllable Expenses

Controllable expenses are operating expenses the landlord can adjust or influence, such as payroll. Operating expenses that are not uncontrollable are controllable.

Capital Expenditures

Capital expenditures are expenses that enhance the value of the building and are included the landlord’s balance sheet as assets. Usually, these are major expenses, such as roof replacement, parking lot pavement, lobby upgrades, renovation of hallways, or bathrooms that are not minor repairs.

Negotiation Strategies

With the help of a tenant’s broker or attorney, tenants should negotiate CAM provisions to assure that they aren’t paying more than their fair share. Some areas where CAM charges may be negotiable include:

Base Year

The beginning rent amount typically assumes a set amount for CAM charges, frequently based upon annual charges in the year before the lease is signed (Base Year). Tenants pay their pro rata share of increases in CAM charges over the Base Year amount. Frequently, a tenant can negotiate the Base Year to be the year when the lease is signed, rather than the previous year. Tenants signing leases late in the calendar year may negotiate so the Base Year is the first full calendar year of the lease term. Tenants negotiating leases renewals should request an update of their Base Year for CAM charges.

Cap Controllable Expenses

Tenants should request a cap on annual percentage increases of controllable expenses in CAM. Landlords often will agree either to a cap based upon the Consumer Price Index (CPI) or a fixed percentage ranging from 3-5%. It is rare for landlords to agree to caps on increases for uncontrollable expenses.

Minimum Occupied Percentage

Tenants should ask that their pro rata percentages their leases as a percentage of all rentable space in the building. However, many landlords won’t agree to this because it is rare for a building to be 100% occupied. Many landlords calculate the tenant’s pro rata percentage based upon the tenant’s percentage compared to all space occupied by tenants in the building. In a building that has low occupancy, the tenant can pay a much higher percentage of CAM charges than it would pay if the building were close to 100% occupied. Tenants should negotiate a minimum assumed occupied percentage. Eighty-five or ninety percent is reasonable. The minimum occupied percentage should be a minimum, not an assumed occupancy. If the building occupancy is higher, that higher percentage should be used to compute the tenant’s pro rata percentage.

Exclude or Amortize Capital Expenditures

Landlords frequently will attempt to include capital expenditures in CAM, even though under accounting rules, those expenditures would be depreciated over several years. Tenants should attempt to negotiate allocation of capital expenses to CAM (if at all) under either tax accounting or generally accepted accounting principles (GAAP), which spread those costs over several years.

Administrative Fees Some landlords will try to include an “administrative fee” or “operations and maintenance fee” in CAM. These administrative fees differ from the property management fees (which are legitimate operating expenses). Sometimes, administrative fees are buried in a “miscellaneous” or other vague cost line item based upon a flat percentage. If the landlord has legitimate common area expenses, they can and should be listed in the lease, rather than buried inside of percentage fees.

Exclude Costs of Ownership

The Landlord’s costs of owning the building are not proper CAM. Most landlords will not attempt to include their mortgage interest in CAM. Still, they might try to include audit costs, accounting costs, legal fees not relating to building operation, building marketing, and other expenses from which the tenants don’t benefit. Tenants should negotiate so CAM charges include only charges that benefit tenants. For instance, legal fees involved in reducing real estate property taxes may be CAM in the years where the fees helped reduce taxes that the tenants pay. Legal fees incurred to evict a tenant or defend a slip and fall case should not CAM.

Exclude Reimbursable Costs

CAM should never include costs reimbursable from another source. Repairs covered by insurance, eviction costs, tenant improvements, and real estate broker fees should not be included in CAM.

Conclusion

Just as instrument repair costs can be an unwelcome surprise for parents of student violinists, CAM charges can be unwelcome surprises for commercial tenants. Parents can minimize the surprises by purchasing repair and maintenance plans, but those plans aren’t available to commercial tenants. Tenants, however, can minimize surprises through careful negotiation of CAM language in their leases.

This series draws from Elizabeth Whitman’s background in and passion for classical music to illustrate creative solutions for legal challenges experienced by businesses and real estate investors.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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