Regardless of the asset class, a commercial real estate property consists of two major components:
- Space that the owner leases to a tenant (store, office, apartment, warehouse) in return for a base monthly rental payment; and
- Common space that is used by all tenants in the property, like a parking lot, office lobby, loading dock, hallways, restrooms, and elevators.
Depending on the type of lease offered by the owner, the cost associated with operating common spaces can be charged back to the property’s tenants in the form of Common Area Maintenance Fees.
What Are Common Area Maintenance Fees
As the name suggests, Common Area Maintenance (CAM) fees are costs that a property owner charges to tenants, on top of their base rent, to pay for the operation/upkeep of common spaces in a commercial 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.
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.
Common Area Maintenance Fee Underwriting Implications
Whether an investor is purchasing a commercial property directly or investing indirectly through a private equity firm (like ours), detailed understanding of the CAM fee structure is critical to the accuracy of the proforma and the projection of potential returns.
The value of any given commercial property is rooted in the Net Operating Income that it produces. Net Operating Income is a property’s total income, less its expenses so Common Area Maintenance fees hit both sides of the calculation. In other words, the higher the amount of Common Area Maintenance charges that an owner can be reimbursed for, the higher the Net Operating Income the property produces. 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.
Again, whether a property is being underwritten as a direct purchase or an indirect investment, it is critically important to dig into the details of the CAM reimbursement structure to fully understand how it affects the property’s Net Operating Income (and therefore value).
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.
As part of our pre-purchase due diligence process, we spend a significant amount of time reviewing tenant leases to understand the CAM reimbursement structure and we build it into our financial models. Doing so allows us to fully understand the finances of the property and to create a more accurate proforma.
To learn more about our investment opportunities, contact us at (800) 605-4966 or email@example.com for more information.
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