By: Jack Nugent, Director – Meridian Realty Consultants, Inc. and
Rudolph E. Milian, President and CEO – Woodcliff Realty Advisors, LLC
“Leasing agents quoting reimbursable CAM and taxes get post-pandemic pushback from prospective tenants on extras more than anything else during lease negotiations.”
Nothing can be more frustrating to a leasing professional after submitting an LOI (short for “Letter of Intent”) to a tenant broker than getting a snappy reply that the operating charges are not competitive.
Tenants and leasing folks are trying to make heads and tails of market rents today, and they often ask their peers: What do CAM and taxes run at open-air centers nowadays? The answer is a resounding: It depends.
The fact is, CAM (Common Area Maintenance) and taxes vary widely from shopping center to shopping center, even similar properties located just a few miles from each other. In reality, rates can vary wildly within a single shopping center. Why?
There is NO such thing as average CAM rates
There really is no such thing as average CAM rates or property taxes per square foot to use as guidance in negotiating shopping center leases. The extra charges vary from center to center because of the way landlords recover CAM costs; the region in which the shopping center is located; whether the tenant has agreed to full triple net recoveries (NNN), and the number of anchors that pay less than their pro rata share due to negotiated limited CAM recoveries, which results in every other tenant picking up the leakage, to name a few variables.
Then, add to the complexities such things as the type of shopping center (for example, open-air community centers being less maintenance intensive pay less than lifestyle centers and malls). How about the age of the center? Newer centers have fewer costs allocated to parking lot and roof resurfacing while older centers have a lot of repairs, which are recovered through CAM.
Rates can vary widely from center to center … even within a single shopping center.
Does the landlord provide trash removal for the tenants? Some landlords dump all common area and premises trash costs – except anchors and restaurants – in CAM. Others charge tenants for the trash handling, hauling and landfill costs as a separate line item prorated for each tenant. Yet, other landlords have the tenants contract directly for the service – so it is not even an expense paid to the landlord (skewing the CAM rate because they are not apples-to-apples comparisons). Along those same lines, do the tenants contract directly for water or is there only one main water supply line for the center, causing the landlord to have to bill for lease premises usage?
All that said, we can suggest that based upon reviews of thousands of leases and hundreds of properties for scores of landlords every year, on an anecdotal basis, grocery-anchored open-air centers have CAM recovery per lease in the range of $6 to $8 per square foot (including common area liability insurance but excluding all risk/property insurance and premises consumables, such as trash and water). Lifestyle centers often run 150-200% of those numbers, while enclosed malls can be double, triple or four times that high depending on energy costs, mechanical equipment, such as escalators and elevators, etc. However, since the early 2000s, about 85% of (enclosed) mall CAM has been converted from pro rata to fixed CAM with annual increases meant to keep up with inflation.
Moreover, these are typical rates for open-air centers. Again, based upon the anecdotal evidence, about 35% of leases fall in that range; roughly another 25% of CAM rates fall below that and the remaining 40% are above that range. Comparing apple to apples, these ranges are net of taxes and all-risk insurance coverage, and no premises/leasable area consumables in those numbers.
Why CAM rates vary
A typical 400,000-sq.-ft.-power center (one with several large anchor big boxes) might have total CAM expenses of $2.8 million. If the center were fully leased and occupied and every tenant paid its full pro-rata share of CAM, the tenants would be paying $7 per sq. ft., according to a simple math calculation ($2,800,000 / 400,000 = $7.00). However, based on how the leases were initially negotiated, a tenant in that center could be paying anywhere from $0 to $15 per sq. ft. in CAM or even higher. There really are hundreds of variables that affect CAM rates.
Why would a landlord do this? In theory, a landlord’s earnings before income taxes, depreciation and amortization or EBITDA would equal minimum and percentage rents billed plus non-rental income. That’s the whole idea behind triple net rents (NNN). The landlord gets the base and percentage rents, the tenants pay all the operating expenses. That’s the landlord’s gross profits for the risk the landlord takes for owning real estate. From that gross profit, the landlord has additional expenses, which fall below the EBITDA line, like interest on the mortgage loan, for example.
Any operating expenses not collected from the tenants would be considered “absorption.” A landlord makes every effort to minimize this absorption to get its EBITDA as close to base and percentage rents as possible. To do so, it structures its standard lease form to ensure it reduces that absorption to a minimum. What does that even mean?
Let’s do the math
Using that 400,000-sq.-ft.-center with $2.8 million in CAM expenses, if the center were fully leased, we would have:
Assuming the center is fully occupied and all tenants pay their full pro rata share of all costs, the landlord bills and collects:
However, let’s say this shopping center – although fully leased at the end of the year – had some turnover during the year. For example, one 75,000 sq.ft. big box vacated on Jan. 31 and remained unleased until a new tenant’s lease commenced on Nov. 1 of the same year. That means we had nine months (nine twelfths or 75% of one full year) of downtime on 75,000 sq. ft. whereby pro rata expenses for that space were not reimbursed. That equates to 56,250 sq. ft. (75,000 x 75%) that had not paid its pro rata CAM for the lease year in question.
If every single lease CAM recovery were based upon the leasable area of the center, we would have:
There are hundreds of variables that affect CAM rates.
That means the landlord would have absorbed $393,750 from the nine months of downtime on the 75,000-sq.-ft.-space. Turnover happens every year. Landlords expect that. So, what do they do about that? The standard lease is written to bill based upon the leased area of the center rather than leasable area as defined in the lease for CAM recovery.
By doing that, if every tenant were governed by the same standard lease, we would have:
So now, tenants on the standard lease would be paying not $7.00 but $8.14545 per sq. ft. for CAM using the same annual costs of maintaining the shopping center.
If all tenants were held to this same standard lease obligation, our billings would look like this:
How do you calculate CAM; leasable or leased?
The above example is clearly a simple example. However, even in this very simple example, one word in the lease used to describe how the tenant’s CAM shall be calculated can make a big difference. That word is leasable or leased.
The lease language pertaining to the tenant’s agreement to reimburse the landlord for the tenant’s share of all operating expenses is worded something like this: “Tenant’s share of operating expenses shall be calculated by multiplying the operating expenses by a fraction, the numerator of which shall be the square feet of the interior portion of the premises and the denominator of which shall be the leased square feet of the shopping center, including the interior portion of the premises, as of the commencement of the applicable calendar year.” However, some leases state leasable instead of leased: “…the denominator of which shall be the leasable square feet of the shopping center,” which can make a big difference in the recoveries.
As you can see, the tenant’s percentage of the total gross leasable area almost always results in lower costs allocated to the tenant as opposed to the tenant’s percentage of the total gross leased area because in the former the landlord is obligated to pay the share of CAM that is allocated to the unleased space whereas in the latter, the tenants – and the tenants alone – are responsible for their proportionate share of all the costs. As a result, if one tenant succeeds in negotiating its standard lease template by just one word in the clause from leased to leasable, its rate per square foot for CAM is no longer $8.14545 per sq. ft. as noted in the previous example. It is $7.00 per sq. ft.
Leased vs Leasable
That minor change in lease language might be done during the attorney review process called lease comments by the tenant’s attorney crossing out just two letters “-ed” and replacing it with “-able,” a seemingly minor change that saves the tenant $1.15 per square foot, a leakage which now the landlord is obligated to pick up for the entirety of that lease term.
And, as we mentioned, there truly are hundreds of variables that affect CAM rates. In order for landlords to have their net operating income or EBITDA be as close to base and percent rents, they have to consider any scenarios that might otherwise cause absorption.
For example, big-box tenants might negotiate a fixed CAM number, such as $4.00 per square foot with annual increases tied to a CPI index. Not only that, anchor tenants can negotiate for a cap on CAM or negotiate that costs relating to resurfacing of the parking lot can be included in CAM only once every seven years or any number of tenant covenants we have seen over the years.
Landlords know these anchors have leverage. They expect it, so, the standard lease is written to exclude lease premises greater than 15,000 or 20,000 or some other threshold square footage. Let’s go back to our example, and we’ll demonstrate how.
If just one 50,000 sq. ft. big box negotiates a $3.00 per sq. ft. cap, the recoveries are broken down in this manner:
However, if the small shop standard lease language excludes this one big box by excluding premises greater than 40,000 sq. ft. from the denominator. we would have:
So, if every other tenant were bound by the standard lease recovery language, which excludes premises greater than 40,000 sq. ft., we would have:
The landlord’s leasing agent is typically given the CAM rate to quote based upon the standard form lease and the prospective tenant’s pro rata share of the latest operations CAM budget. But change just one of those hundreds of variables in the lease language for recovering CAM expenses and the CAM rate could drop by 10%, 20%; or even as high as 90%.
One change in those hundreds of variables, and the CAM rate could drop by 10%, 20%; or even as high as 90%.
Often, tenants are focused on total rents, comprising minimum rent, percentage rent, if applicable, CAM, insurance and real estate taxes, and sometimes even marketing charges or other landlord charges that affect the tenant’s total occupancy costs. If they are targeting a total rent of $40 per sq. ft., and the leasing agent quotes the standard lease rates of $9 per sq. ft. for CAM, $5 per sq. ft. for taxes and $1 per sq. ft. for all risk insurance, the landlord and tenant might settle on a fixed minimum rent of $25 per sq. ft. ($40 – $15 in extras = $25 in base rent). Accordingly, an LOI goes out with a base rent of $25 per sq. ft. plus the tenant’s pro rata share of CAM, taxes and insurance.
If during those negotiations, the tenant strikes leased and makes it leasable and convinces the landlord to change the definition of what constitutes an anchor tenant from 40,000 sq. ft. to 60,000 sq. ft., the landlord might have left $2 per sq. ft. on the table because the landlord can no longer deduct the vacancies and the 50,000 sq. ft. anchor tenant is no longer defined as a major. And, to add insult to injury, the tenant may have been making its monthly escrow payments based upon the original CAM quote, and the landlord then has to give a $2 per sq. ft. credit at year-end.
Ultimately, the variables in how to calculate CAM in a lease can have much more of an impact on CAM rates than the definition of the expenses actually included in CAM.
Why does this all matter so much?
Why does this all matter so much? In our first example, with the big box vacant for nine months, we have $393,750 in absorption. If we apply an 8% cap rate on that absorption we have given up nearly $5 million in value – all because we did not change our CAM recovery lease clause from leasable to leased.
Leasing professionals – whether representing the tenant or the landlord in a lease negotiation – generally understand why the landlord needs to recover its operating costs from the tenants in the shopping center and why anchors also contribute but not usually in proportion to the small shop tenants on a per-square-foot basis. However, leasing reps are not lease accountants and are not expected to explain exactly why additional rents meant to recover expenses vary so much from shopping center to shopping center.
What is important is the total occupancy costs that a tenant is expected to incur per year as a percentage of anticipated annual sales to ensure the retailer is profitable, something every landlord wants of its tenants.
Is $40 per square foot in rents and extras too high? Not if the tenant will generate between $400 and $500 per square foot in annual sales.
However, if this retailer is paying $40 per sq. ft. in total occupancy costs but is only generating $225 in annual sales per sq. ft., the ratio of almost 18% of rents to sales might not allow the retailer to make a profit after cost of sales and other retailer costs are deducted from gross sales.
Rents should always be viewed in the context of sales. For that reason, retailers need to come into the deal with an understanding that the proposed space is neither too big nor too small and be able to project what kind of sales they can generate in that space, even before asking the landlord agent to quote rents. How else would a tenant be able to evaluate if the rents and extras are too high?
- Meridian Realty Consultants: “Remember that premises services (utilities/trash) are not common area expenses!”
- Commercial Lease Law Insider.com : “Don’t Agree to Keep CAM Costs “Competitively” Priced
- ShoppingCenters.com : Tips and Strategies for Renting Your First Commercial Space
Jack Nugent, CRRP
Director | Principal at Meridian Realty Consultants
Jack Nugent, CRRP is a director for Meridian Realty Consultants, Inc. of Philadelphia responsible for operations of its Greater Atlanta office, where his major focus includes due diligence, lease audit and review, property transitioning and property management consulting. Meridian Realty abstracts and underwrites thousands of leases per year. Mr. Nugent is part of a team of consultants working with Woodcliff Realty Advisors.
Rudolph E. Milian, CRRP, CRX, CSM, CMD
President & CEO of Woodcliff Realty Advisors, LLC
Rudolph E. Milian, CRRP, CRX, CSM, CMD is president and CEO of Woodcliff Realty Advisors, LLC, a full-service consultancy serving retailers, commercial real estate owners, capital investment firms and service providers in Canada and the U.S. based in the New York area. Woodcliff works with a couple dozen consultants each specializing in a different field. He has equity ownership interest in mixed-use and open-air community centers.