Businesses leasing commercial space should expect to pay common area maintenance (CAM) costs in addition to rent. Also known as operating expense recoveries, CAM costs fund the property’s CAM, such as elevator maintenance fees, building security costs, or property taxes.
Well-defined lease language is critical when it comes to controlling and auditing CAM charges. Establishing clear lease language around CAM expenses can facilitate transparency and control over passed-through CAM charges throughout the lease term.
Below are five lease language best practices to consider during lease negotiations that can protect your business from excessive CAM charges:
Clearly Define Expenses
Allowable CAM charges should clearly define allowable charges to avoid disagreements over interpretation. Take time to detail the allowable charges so that all parties understand what is and isn’t a reimbursable expense. For example, labeling an expense as admin costs isn’t the same as labeling it salaries and fringe benefits of the on-site property management team, office supplies, and Owner approved IT expenses necessary to operate the building. The latter provides more specificity and ensures landlord and tenant have a shared understanding of allowable costs.
Include Due Diligence and Benchmarking Clauses Surrounding Third Party Vendors
Industry best practice suggests property owners and managers bid out routine CAM related services, such as janitorial, security, landscaping, HVAC maintenance, every three years at a minimum. Including language requiring CAM services undergo a due diligence process can help control third-party vendor costs and their impact to overall expenses.
Incorporating language that allows for benchmarking reported expenses against industry standard or comparable properties can help establish a basis for evaluating the reasonableness of expenses if questioned.
Clarify Capital Expenditure and Amortization Definitions and Allowability
Clearly establishing eligible amortization costs and amortization criteria can also help control CAM charges and remove ambiguity from fee discussions. Evaluating amortization-related language requires examining multiple facets of the amortization process and agreeing how each element will be handled during the term of the lease.
To create clear amortization criteria language, ask the following:
- Allowable Capital Expenditure. Is the improved asset a lessee or a lessor cost? Defining which capital expenditures, if any, are a lessee cost can avoid timely or costly disputes.
- Useful Life. Is the useful life of each eligible expense defined so the allocating costs basis over time is established?
- Amortization Method. Are amortization costs straight-lined or is the declining balance method used?
- Amortization Commencement. Does amortization begin at the completion of an improvement or the start of the lease term?
- Amortization Period. Will amortization occur over the entire lease term or another timeframe?
- Calculation. What accounting standards will be used?
Establish Expense Caps and Nonallowable Charges
Expense overruns happen and certain CAM costs naturally fluctuate, such as utilities, facilities maintenance, internal facilities personnel, and or IT charges. Setting expense caps and defining unallowable charges can protect against excessive operating costs for big dollar items, like capital expenses or insurance premiums year over year.
Include Right-to-Audit Clause and Reporting Requirements
A right-to-audit clause allows tenants to review, confirm, and validate accurate billing on a regular basis. This clause can be helpful to landlords as well as it sets clear expectations on documentation requirements and limitations. Specific details to pay close attention to include:
- Audit Notice Requirements. The lease language should delineate if written notice of an audit is required, specify if there is a time limit for audit initiation from receipt of the annual reconciliation package, as well as the time given for landlord’s audit preparation.
- Audit Timeline Restrictions. The right-to-audit clause should indicate how long tenants have to complete the audit. At least 90 days upon receipt of all records is best practice.
- Remedies. If miscalculations are identified, the lease language should specify whether reimbursement will be check, statement credit, or adjustment to CAM estimates.
- Audit Cost. Both landlords and tenants should consider establishing a CAM audit plan performed by a neutral and objective third party to facilitate overall cost efficiency and transparency. This can be both a great tool for both parties to implement best practices, identify and mitigate early risks identified through trend analysis, and demonstrate transparency and accountability.
- Audit Access. Clearly note that access to all relevant records and documentation related to the CAM expenses under review will be provided, including invoices, receipts, copies of checks, service contracts, timecards, and other documents which may support the charges.
- Reporting Requirements. Define clear reporting requirements, preferably quarterly but at least annually, to understand potential cost fluctuations so you can proactively plan and manage cashflow.
We’re Here to Help
For more information about using lease language to control operating costs or to perform a CAM audit, contact your Moss Adams professional.