Sophisticated commercial tenants generally understand that the cost of leasing space is not limited to rent. Most retail and higher end office spaces are net leases and therefore, include a separate charge for Common Area Maintenance and Operating Expenses (CAM). CAM charges are the charges that the landlord incurs for running the common areas of the building, such as utilities, maintenance, taxes, insurance, security and the roof and structure. Depending on the tenant’s size and financial strength, care should be given to negotiating what is included in the definition of CAM and what is specifically excluded. I’ve written on this topic before (see post HERE).
Another factor in negotiating CAM from the tenant’s perspective is limiting the increase from year to year. Again, there are tools to help limit tenant’s exposure to significant increases to CAM charges (discussed in my previous post and also HERE). But once the CAM provisions have been negotiated and included in the lease, tenants can’t forget about them. If they do, tenants could be faced with improper CAM increases or charges.
In my practice, I am asked what to do about large CAM increases all the time. When I have been the one to have negotiated the lease, the process is usually simple and the same. There are 2 questions of concern. First is the reconciliation of the prior year’s CAM. That occurs because landlord has underestimated the actual operating costs for the building for the prior year and tenant is required to “true-up”. The second is the new charge for the coming year. If landlord under budgeted for the prior year, the new charge should factor in the short-fall plus a percentage increase for the coming year so that the tenant will not suffer sticker shock.
The review process is not complicated in a properly drafted and negotiated lease. Within a certain number of days following the end of the calendar year, the landlord should provide an operating statement showing the reconciliation including the original budget and the actual budget. The tenant will have a period of time to object and, if desired, audit landlord’s records to determine accuracy. If tenant’s audit finds a discrepancy over an agreed percentage, landlord pays the cost of the audit and sometimes, a penalty to tenant. If tenant still owes, tenant pays. Tenant also has the right to review the proposed budget. If there was an audit, the audit should give the tenant some insight as to the accuracy of the new budget.
If landlord fails to timely deliver the reconciliation, landlord waives its right to collect any shortfall. CAM, however, should be adjusted up or down, at any time during a calendar year. While tenants might look at this provision as giving a landlord too much discretion, it is better to make incremental changes during the year than to be faced with a large reconciliation at year end which must be paid in lump sum on 15 days’ notice. And, because tenant should have the right to audit, the payments can be recovered if found to be improper.
Sometimes, actually, often, I get leases that I did not review or negotiate. New clients or even existing clients who didn’t think they needed me or my partners to handle what they considered to be a “simple lease”. Recently, a firm client, who signed a lease before we represented him, was presented with a very large reconciliation. It came at the start of the 3rd calendar year of the lease. This was the first time the client had ever received a reconciliation. He should have received 2 reconciliations previously but apparently, the property manager “forgot” to send the prior reconciliations. As a result, there had never before been a true-up. In addition, the property manager had, for the prior 2 years not increased CAM because he “forgot” to bill the client. Now, the client had a large reconciliation and a large increase. The client had never questioned the property manager, but why would he? His rent increases were small and the CAM wasn’t changing. On the other hand, now he faces a very large bill.
How can the client be certain that the property manager isn’t attempting to recoup the lost CAM going back to the first year? The issue is sloppy record keeping. By not presenting timely reconciliation statements, the lease provides that the true-up is waived for those first 2 years. Therefore, the landlord is only entitled to catch up for last year. But the sloppy property manager never even prepared a budget those first 2 years so there is no documentation to prove that the client underpaid last year or to prove that the reconciliation is only for last year and not a recovery of all lost CAM. The best that property manager and landlord can do is show us tax and insurance bills over the life of the lease to prove that non-controllable expenses.
In hindsight, I have explained to the client, the lease requires that the landlord provide a budget by December 1 of each year. That budget is to include a CAM estimate for the coming year. The estimate should prepare the client for what is to come in the reconciliation statement. Although these are landlord’s obligations, if the tenant does not keep its eyes open and be aware, a big surprise will come at some point. That surprise is likely to turn into a costly fight.