For many businesses, the start of a new year holds exciting opportunities as they look toward the future. But for companies that signed leases on or around January 1, the new year can also bring unexpected challenges in the form of rent increases that can cause real estate budgets to soar.
While base rent increases should come as no surprise to tenants - they're spelled out in the lease - it's important for businesses to pay close attention to escalations in "additional rent," which typically includes operating expenses and real estate taxes. Sometimes referred to as Common Area Maintenance (CAM) charges, these fees are allocated to tenants on a pro rata basis on top of the base rent they're required to pay each month. For example, if Company A leases 10,000 square feet in a building with 100,000 square feet of usable space, it may be responsible for 10 percent of the CAM charges.
Landlords use this additional rent to pay for a variety of operating costs, including everything from security and landscaping services to snow and trash removal. But CAM charges can also include expenditures that should not be passed through to tenants, including but not limited to:
- capital expenditures designed to increase the long-term value of a property
- costs the landlord will eventually be reimbursed for through insurance or some other means
- costs of alterations or relocations of tenants within the building
- depreciation charges
- interest and principal payments of mortgages
- legal fees in connection with negotiating leases with other tenants in the building or in connection with the enforcing lease obligations of other tenants in the building
- real estate brokerage and leasing commissions
- marketing/advertising expenses incurred in connection with the leasing of the building
- fines assessed to the landlord for violating laws or ordinances
The list is a lengthy one, and a good lease will spell out which items should be included in a firm's rent to avoid landlord-tenant disputes. Unfortunately, not all landlords comply, and because they're the ones who are ultimately responsible for calculating tenant CAM charges, it's up to the tenant to ensure they are not overpaying. This process should begin before a lease is signed, and includes three key safeguards:
- Audit rights:When negotiating a lease, tenants should insist on an audit clause that gives them the right to review their landlord's expenses at least once per calendar year. The benefits of this are twofold: Tenants are not only able to investigate questionable charges, but their ability to do so discourages landlords from including them in the first place. Without giving themselves this option, tenants run the risk of having their landlord lump expenses into ambiguous categories like "other" or "miscellaneous" and may not be able to determine what they're actually paying for.
- CAM caps: Another way tenants can protect themselves against unpredictable rent hikes is negotiating first-year and ongoing CAM caps that dictate how much these fees can increase over the course of a lease. These can take on a variety of forms, such as:
- Gross leases: Unlike a net lease, in which CAM charges are assessed separately, gross leases allow tenants to pay a fixed - albeit higher - rental amount that is used to cover taxes and operating expenses.
- Year-over-base caps: Year-over-base caps allow CAM charges to increase by fixed percentages over the first year, or base year, expenses. These can be calculated on a cumulative or compounded basis.
- Year-over-year caps: With year-over-year caps, CAM charges increase by fixed percentages over the prior year's actual expenses. If expenses fall below the cap in any given year, the following year's cap is calculated using the lower amount, making this structure less appealing to landlords. Like year-over-base caps, these can be calculated on either a cumulative or compounded basis.
- Assignment/subletting provisions: While audit rights and CAM caps should help eliminate unexpected real estate costs, it never hurts for tenants to give themselves an "out" in case their ability to cover real estate expenses changes over the course of their lease. Having the option to assign or sublet their space to another business allows tenants to move to a more affordable location if their costs end up being higher than expected.
Of course, the best way for tenants to ensure their lease includes all of the necessary CAM safeguards is to work with experienced real estate professionals like brokers and attorneys, who can help negotiate a lease and review the final document before it is signed. Doing so will save businesses time and money - not to mention headaches - in the long run and prevent them from becoming trapped in a space they're unable to afford.
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Frank Chalupa is president and co-founder of Amata Office Solutions, a Chicago-based real estate provider specializing in office solutions for companies requiring up to 10,000 square feet of office space. For more information, visit www.amataoffices.com.