A tenant’s share of the costs to operate and maintain common areas of a property can be a significant financial component of a commercial lease. The underlying common area costs are detailed in a lease clause called ‘Common Area Maintenance,’ ‘Operating Expenses,’ or something similarly titled. This section describes the types of expenses that can be charged back to a tenant. Common area maintenance (“CAM”) clauses can be highly negotiated and, as a result, the clause may be unique to each tenant in a building. For tenants, negotiating language creates an opportunity to clarify their responsibility for operating expenses, but for landlords, it can cause extra work when preparing reconciliation billing. This article explains five important things to Know. Right. Now. about CAM clauses, including definitions, inclusions and exclusions, and expense adjustments.
1. What is Common Area?
‘Common Area’ may be a defined term in a lease and typically includes those portions of a building or a property that benefit all tenants equally. This includes areas such as lobbies, elevators, multi-tenant hallways and restrooms, lounge areas, non-exclusive parking and outdoor space, behind the scenes engineering areas and others. Individual tenant spaces, exclusive use lobbies and restrooms, and other limited access spaces are not typically included in the definition of common area unless specified in a lease.
2. What are Common Area Maintenance Costs?
The simple answer here is that common area maintenance costs are those costs related to operating and maintaining the common areas. This, too, may be a defined lease term and in many cases, the clause will begin with something like this:
‘Common Area Maintenance Costs includes all costs and expenses incurred by Landlord in relation to operating, maintaining, and repairing the Building and the Property.’
The wording of this first sentence sets the broad guidelines for the tenant’s financial responsibility.
It is important to review this opening sentence carefully. The intent of the clause is to ensure the landlord is reimbursed for their cost of regular, ongoing operations. However, be mindful of words deviating from that premise such as the words owning, replacing, refurbishing, and others that could fall outside of what would be considered normal ongoing repairs and maintenance. Including this language in the broad definition could imply that the landlord may improve their asset at the cost of the tenant.
3. Specific Inclusions and Exclusions
Following the initial definition of common area maintenance costs, there are usually stated lists of specifically included and excluded expenses. Inclusions and exclusions can be unique to each tenant, especially with larger leases where the tenant may have the ability to negotiate this language. Ideally, the lists should align with the broader definition of common area maintenance discussed above. However, in situations where an expense is specifically included but does not align with the broad definition, it is appropriate to include the expense in common area expenses absent additional information supporting its exclusion.
Inclusions typically incorporate all regular operations a landlord oversees, including utilities, insurance, janitorial, maintenance, security, and other costs resulting from operating a commercial property. Some frequently excluded expenses are advertising and promotion expenses, depreciation and amortization, loan interest, late fees, and general corporate overhead. Understanding how the tenant’s share of common area costs is calculated can shed light on where inclusions and exclusions can favor either the landlord or tenant. One example of this is the inclusion of real estate taxes in the definition of common area maintenance. If the lease has a cap on expenses, including these in common area expenses can have a dramatic effect on a tenant’s overall financial responsibility.
4. Capital Expenditures
The accounting description of a capital expenditure is one that extends the useful life of an existing asset, replaces or improves an existing asset, or benefits more than one accounting period. Some common area maintenance definitions will exclude capital expenditures in their entirety. Other definitions include capital expenditures incurred for cost saving or governmentally mandated projects. When determining whether a cost is an expense item or capital expenditure, consider the following questions: Do the costs benefit more than a single annual accounting period? Is there a replacement, an upgrade, an increase in value, or extension of an asset’s useful life because of the work? If the answer is yes, the expenditure may be considered capital in nature.
Sometimes a lease will allow an amortized portion of a capital expenditure to be included in the common area expenses over multiple years. If this is the case, the included amount is calculated by the landlord. The calculations and supporting components should be reviewed for accuracy and alignment with the lease. This includes contracts and paid invoices, projected and actual cost-savings, payback and amortization schedules, a determination of the useful life of the expenditure, and details relating to the interest rate and amortization period used.
5. Other Adjustments
Common area maintenance costs also may include other adjustments to the actual expenses incurred, such as gross up adjustments, reserves for capital repairs, and adjustments for partial occupancy years. These adjustments may be stated within the same section of the lease or in an addendum and are added to or deducted from common area costs.
Adjustments can be calculated in several different ways. For example, a gross up adjustment considers a building’s occupancy and the fixed versus variable expenses of the building. Occupancy can be calculated based on the amount of space leased or the amount of space physically occupied by people. The division of expenses into fixed and variable components is subjectively determined in many cases. Fully understanding the theory and mechanics of these adjustments is critical to ensuring that they are properly calculated and in alignment with the lease.
These five things are only a few of the many topics that affect the calculation of common area expenses. Always look to the lease for guidance on how these points impact your unique lease situation. Scribcor professionals who specialize in lease audit can offer cost avoidance strategies and support lease compliance. If your organization is looking to reduce real estate spend and recover overbilled amounts, please contact me at (630) 601-7233.