Imagine a typical retail shopping center. There is an anchor tenant and a number of supporting tenants whose businesses are housed in connected retail storefronts. These storefronts represent the Gross Leasable Area.
In this shopping center, there is also a parking lot, landscaping, walkways, elevators, and lobbies that are shared by all tenants. These spaces are referred to as “common areas” and the responsibility for their upkeep is addressed in commercial real estate tenant leases in a section called Common Area Maintenance Charges.
What Are Common Area Maintenance Fees
Common Area Maintenance Charges or CAM Charges are additional fees (above base monthly rent) paid by tenants to landlords to cover the costs associated with the maintenance of common areas in a commercial real estate property. The actual amount of the fee for any given tenant is proportionate to the share of the total space that they lease.
To illustrate this point, an example is helpful. Assume that a property has 5,000 square feet of rentable square feet and four tenants who lease space as follows:
In this configuration, Tenant #1 is responsible for 50% of the operating expenses, Tenant #2 is responsible for 30% and so on. The exact expenses that a tenant is responsible for are negotiated as part of the lease agreement.
Controllable vs. Uncontrollable CAM Charges
Generally, CAM charges fall into one of two categories, controllable expenses or uncontrollable expenses.
What are Controllable Expenses?
Controllable expenses are those that can be controlled by the commercial real estate property manager and/or owner. Examples include things like payroll and commercial real estate management.
What are Uncontrollable Expenses?
As the name suggests, uncontrollable expenses are those for which the commercial real estate property management company or owner has no control. These could vary from month to month based on usage and include things like utilities and snow removal.
What is Included in CAM Charges?
CAM expenses include the cost of repairing, maintaining, and cleaning the common areas of a commercial real estate property. The specific costs are determined by the real estate landlord and outlined in the tenant leases for the property. They can vary widely from one property to another, but there are a number of examples that are common:
Parking Lot Maintenance
CAM charges pay for the costs of sealing parking lots, repairing their cracks, and resurfacing them when needed.
Lawn Care and Landscaping
If the commercial real estate property includes a significant amount of landscaping, it can be expensive to maintain. CAM charges for landscaping can include things like: mowing the grass, pulling weeds, trimming the trees and maintaining the sprinkler/irrigation system.
Ensuring that sidewalks are free of snow and ice and repairing broken sections is a safety issue. It is in the best interest of both the tenants and the owner to ensure they are kept in top shape for the comfort and enjoyment of all shoppers.
If the utilities for a commercial property are not separately metered, then it is customary for the tenants to split the cost.
There are other CAM charges than those mentioned above and the tenant’s lease should be read in detail to determine which are addressed.
Examples of Common Area Maintenance Fees
When negotiating the amount of Common Area Maintenance Fees, the property owner and tenant have conflicting interests. Ideally, the property owner would pass all of the property’s operating expenses through to the tenants. Conversely, the tenants would like to pay as few as possible. So, they negotiate, which means that the actual Common Area Maintenance fees can vary widely from one property to another. In general, they can be divided into expenses that are controllable and those that are not.
Controllable expenses are line items that the property owner can directly control. These could be things like the cost of property management, landscaping, lighting, and parking lot striping. The owner negotiates the expense for each of these items and passes it through to the tenants.
Non-controllable expenses are the opposite, the owner has no control over them. These include things like property taxes, utilities, and snow removal and they can vary widely from one year to the next.
Once the included expenses are agreed upon, it is the property owner’s responsibility to create a budget for the year and to allocate the expenses accordingly to each tenant. The expenses are billed monthly, in addition to the rent and, at the end of the year, the actual expenses are reconciled to the budget. If it turns out that the property owner charged the tenants too much, they will receive a credit for the following year. If it turns out that the property owner charged too little, they will bill tenants for the remainder in a lump sum at the end of the year.
How Are CAM Charges Calculated?
The most important point to remember about the calculation of CAM charges is that they can be different for every tenant and the specific calculation methodology is described within the lease. That said, the calculation of CAM Charges is typically based upon proportion of the total space that a given tenant occupies.
At the beginning of each year, the property owner creates an operating budget for the property. Their figures are based on historical performance and their knowledge of existing service contracts and expense amounts.
Once the budget is complete, the total cost is allocated to each tenant based on the amount of square footage that they lease in the property. The exact formula used to calculate CAM costs for each tenant is defined in the lease agreement, but the formula generally looks like this:
For example, suppose a property has 50,000 SF of Gross Leasable Area and one tenant occupies 10,000 SF or 20% of the total space. So, if total CAM charges were $100,000, the tenant’s proportionate share would be 20% or $20,000.
At the end of each year, the property owner will tally up the exact operating expenses. If they are less than the budget (meaning they collected too much money from the tenants), they will issue a credit to the tenants to offset future CAM charges. If they turn out to be more than the budget, they work to collect the difference from the tenant(s).
Do All Leases Include CAM Charges?
In short, no. The existence of CAM charges depends on the type of lease. Broadly, there are two types of commercial real estate leases, Net and Gross.
CAM Charges in a Net Lease
In a Net Lease, the tenant is responsible for paying a base monthly rental amount plus some portion of the commercial property’s operating expenses, depending on the specific type of Net Lease:
- Single Net Lease: In a single-net lease, the tenant pays the base monthly rental amount plus one of the three major operating expense categories, taxes, insurance, and maintenance.
- Double Net Lease: In a double net lease, the tenant pays their base monthly rental amount plus two of the three major operating expense categories: taxes, insurance, and maintenance.
- Triple Net Lease (NNN Lease): In a triple net lease, the tenant pays a base monthly rental amount plus all three of the major operating expenses categories: taxes, insurance, and maintenance.
CAM Charges in a Gross Lease
In a Gross Lease structure – sometimes called a full service lease – the tenant pays a fixed monthly rental amount and the real estate landlord pays for the commercial property’s operating and maintenance costs. As a result, the base rental amount tends to be higher so the real estate owner can recoup as much of the maintenance costs as they can.
In other words, a Gross Lease does not include excess CAM charges, they are built into the monthly rental amount.
Gross Lease vs. Net Lease CAM Charges
At a high level, there are two major types of commercial leases: gross and net. It can be helpful to think about these as being on opposite ends of a spectrum.
On one end, a Gross Lease has a payment structure where the tenant makes one monthly payment and the landlord is responsible for all of the property’s operating expenses. This arrangement makes it easier for the tenants because they just have to pay one monthly amount. But, the monthly rent is usually higher because the property manager uses some portion of it to offset the operating expenses.
On the other end of the spectrum is a Net Lease, where the tenant pays a lower monthly amount plus some portion of the property’s operating expenses. This structure gives the tenant a lower base rental amount, but it also exposes them to the risk of rising operating costs.
In reality, the payment structure of most commercial real estate leases falls somewhere between these two ends of the spectrum. In a so-called “modified gross lease,” the tenant pays a base rent amount plus their pro rata share of the CAM expenses.
Common Area Maintenance Fee Underwriting Implications
A typical proforma for a commercial real estate property will show two major income line items: Rental Revenue and CAM Reimbursements. As such, understanding how much revenue to expect from CAM charges is critically important to creating an accurate financial model for the property and a realistic estimate of value.
The commercial property’s income is offset by the operating costs of maintaining it and the cash left over is known as “Net Operating Income.” The amount of NOI that a property produces is a primary driver of value and returns for the investment. So, if CAM reimbursements are modeled too low, NOI would also be low, which would also skew returns low. Conversely, if CAM reimbursements are too high, the property’s NOI, returns, and value could be overstated.
To illustrate this point, consider the following basic example:
Assuming a 7% Cap Rate, there is a value difference of nearly $90,000 based on whether 100% or 75% of the Common Area Maintenance charges are reimbursed.
For this reason, it is important to review every tenant lease to understand how much they are required to pay in monthly rent and how much they are required to pay in monthly CAM charges.
Why CAM Charges Matter
The amount, timing, and payment of CAM charges matter for both the tenant and the property owner.
For tenants, CAM charges can make up a significant portion of their monthly rental expense. So, it is important that they budget for both the monthly rent and CAM charges so they know what their total monthly expense will be.
For the property owner, CAM charges are important because they represent an additional source of income that is used to pay for the property’s operating expenses. This limits the amount of money that has to come out of their own pocket
In the case of the properties that we own and manage, we invest a significant amount of time and resources into the capital budgeting process to ensure it is as accurate and fair as possible. And, we work with all of our tenants to ensure they understand how their rental payment is calculated, and how it can change in any given year due to increases in operating costs.
Conclusions & Summary
Common Area Maintenance Costs are costs that are passed on to commercial real estate tenants to reimburse the owner for the expenses associated with maintaining the common areas of a property.
The methodology used to calculate Common Area Maintenance Fees is outlined in each commercial real estate lease and it can vary from one property to another. However, the most common method is to allocate these costs to each tenant based on their pro rata share of the total square footage in the property.
CAM Fees are typically seen in Net Leases where the tenant is responsible for paying a monthly base rent amount plus their share of the CAM Costs. In a Gross Lease, tenants pay one monthly rental amount and the landlord is responsible for paying the common area expenses.
From an underwriting standpoint, understanding which costs the tenants are and aren’t responsible for reimbursing can have major implications for the creation of the property proforma. If they are understated, the returns would skew low. If they are overstated, returns could skew high.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
When evaluating our own deals, we invest a significant amount of time and resources in analyzing a property’s cap rate relative to other options. We view this as integral to our pre-purchase due diligence process and a factor in our success. If you would like to learn more about our investment opportunities, contact us at (800) 605-4966 or email@example.com for more information.