Beware of Common Area Maintenance Expenses Provisions
If you are a commercial tenant with multiple locations, the legal implications of multiple lease renewals makes it wise to have a experienced advocate. An attorney will make it easier for you to focus on managing your business and help you avoid the pitfalls that can cause serious legal consequences or financial damage.
Mark Works, the majority owner of Works Fitness, Inc., the holding company for a string of independent fitness centers, found himself in a lot of trouble. Mark had always prided himself on being able to handle all aspects of the Works Fitness business, including lease negotiations. Mark opened four new locations in the four years since he started the company.
About 10 months after renewing a lease agreement at one of his facilities, the owner of the property ACE LLC decided to undertake the rehabilitation of the parking lot pavement. It was about time, as extreme weather conditions had caused the parking lot material to expand and contract more than usual, and the movement had begun to take a toll on the lot’s appearance. It looked like a war zone.
When Mark and some of the other tenants complained about the condition of the lot, the owner would send in a crew to complete some minor patching as needed. But this time was different. The landlord finally went the extra mile to solve the issue and decided to do a complete makeover.
A crew came in and pulverized the well-worn top layer of asphalt as well as the underlying granular base. The material was compacted and a layer of hot asphalt applied on the top, creating a sparkling new parking lot – just what Mark and the other tenants wanted.
Operating Expense or Capital Expenditure?
The project cost ACE LLC more than $450,000. Commercial lease agreements typically have a broad definition of “expenses.” Under the Common Area Maintenance (CAM) provisions of its commercial leasing contracts, ACE LLC would recover the cost from the property’s tenants. The landlord intended to amortize the expense over 10 years – the industry’s standard for the useful life of a new asphalt parking lot. Amortization protects shorter-term tenants from bearing the full cost of the project.
A month later, the landlord began billing Works Fitness and the other tenants in monthly installments. For several months, Works Fitness paid its portion of the “expense” at an additional $650 per month. However, a subsequent review of the matter made it clear to Mark that the project exceeded maintenance and repair and should not fall under the CAM provision. He contends that the project should have been treated as a capital expenditure and written off as such.
Beware of Common Area Maintenance Expenses Provisions
Most commercial leases have a Common Area Maintenance, CAM Expenses, or Operating Expenses provision. This clause requires the tenant to pay its pro rata share of the operating expenses incurred by the landlord in the operation and maintenance of the office building, shopping center, or other commercial property.
Typically expressed as a cost per square foot, CAM allows the landlord to pass through to the tenant legitimate expenses that cover the operation and maintenance of the common areas. It should only consist of non-capital costs, such as:
• Cleaning the exterior facade.
• Shared interior cleaning and repairs.
• Parking lot maintenance and repairs.
Despite the intent of the provision, many CAMs are potential traps for unaware tenants because many landlords seek to turn the provision into a profit center. As Mark discovered, CAMs can be a point of heated dispute.
He argued that the parking lot project was a capital expenditure that provided permanent benefit to the property overall, and that it should not be treated as a operating expense, but built into the base rent. Of course, ACE LLC rejected the argument, stating that the extreme weather made the cost unpredictable, which made it impossible to factor into the base rent.
Furthermore, the landlord was merely exercising its right to “pass through” to the tenant operating expenses as allowed under the CAM provision contained in the lease agreement.
Works Fitness Avoids a Potential Financial Burden
Complex issues related to capital expenditures arise frequently in commercial landlord-tenant relationships. In the case of tenants like Works Fitness, an unfavorable outcome regarding the issue can have a profound impact on a company’s bottom line.
In the past, Mark always negotiated the initial leases for his fitness facilities as well as lease renewals. Prior to renewing the lease on the subject property, Mark made a strategic decision to focus on his core strengths – opening fitness centers and putting in place the right people to manage the facilities. Consequently, he decided that he would hire an experienced real estate attorney to handle all aspects of the negotiations for his leased properties, including lease renewals.
The new attorney reviewed current and expiring lease agreements. He quickly identified some causes for concern, especially in the CAM provisions of the contracts, and particularly the one with ACE LLC. Some of the problems he found included:
1. The definition of the base year did not protect the firm against the obligation to pay for expenses during the base year, and it did not subject variable expenses to a “gross up,” which requires the landlord to show the full amount of operating expenses incurred if the building is 100% occupied.
2. The contract also contained a provision that made the property owner’s determination of CAM final.
3. The lease agreement did not contain a cap on CAM charges and allow the tenant to terminate the lease if the expenses exceeded the cap.
After a thorough review of the expiring lease agreement with ACE LLC, the attorney had some negotiation points that needed to be addressed to ensure that his new client had the necessary financial and legal protections. He completed the lease renewal negotiations and eliminated the red flags contained in the CAM and other potential issues.
Fast forward to the subsequent meeting between the principals of both companies and their respective attorneys. It was determined that the cost of the new parking lot could not be passed through to Works Fitness, thanks to the work of the firm’s new real estate lawyer.
Whether you lease one or multiple properties, it’s crucial for you to have competent legal counsel to protect you against one-sided provisions that favor the landlord. Hire an attorney who specializes in commercial real estate law and possesses an appreciation for the various market forces that can affect your bargaining position and business decisions.
What To Do Next:
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