A few more issues related to excluded area contributions

Last week we addressed a few of the issues to consider related to excluded area contributions, but two properties that we worked on this week made me realize I missed discussing two very significant issues – refunds/credits and recaptures as they relate to excluded area tenants.

At one of the properties, an excluded area tenant audited its CAM and tax charges for several years. While the landlord had tried to bill everything in accordance with the terms of the leases, the tenant was entitled to credits of just over $75,000. While painful to issue such a significant credit, since the credit was issued to an excluded area tenant, this actually should have triggered other adjustments. Every tenant in the center with a lease that defined that particular tenant as an excluded area had previously had its CAM and taxes calculated based upon the original contributions. As the credits were issued reducing those contributions, the other tenants were underbilled.

Often, it is impractical to go back to bill the other tenants for their respective share of what may have been $25,000 per year for three years. The typical application of this would be to apply the credit in the ensuing year, without applying the same credit to those tenants who were not there in the years the credits applied.

(This is a bit more advanced, so skip it if you need to. The method just addressed may have a negative impact if some of the tenants have caps that would be affected by a material reduction in any given year. In that case, even though it would be an administrative burden, it would be best to go year by year so as not to set the caps artificially low for any given year.)

The second property had a standard lease for that specifically addressed deducting contributions from majors (definition varied tenant to tenant) where the major did not have the right to “recapture” the contribution against other charges. I will do a blog in the future to specifically address recaptures. But briefly, some tenants (typically majors or the most desired tenants) have requirements to pay a share of CAM or taxes, but then have a right to offset these payments against percentage rent or some other charge. As an example, if a tenant was required to pay $100,000 in taxes, but had $65,000 in percentage rent due, and then tenant was allowed to offset taxes paid against percentage rent, then, with this clause in a lease, instead of a $100,000 contribution from the excluded area tenant reducing allocable taxes, the contribution used would be $35,000 ($100,000 paid less $65,000 “recaptured”).

We usually see tenants granted recapture language perhaps one time out of every three to four retail properties (so maybe .5-1% of leases). In this case, while the standard lease does address recapture language, none of the current majors have recapture rights (we haven’t completed the outparcels which could potentially have recapture rights). Therefore, at this property, it may not even apply.

These two issues are a little more convoluted. Feel free to comment if you have any specific issues needing clarification.

Excluded area contributions

When a tenant pays a prorata share of taxes or CAM, there are often defined excluded areas. Most typically, those defined excluded areas are either directly assessed, self-maintaining or insured, or are paying at a rate significantly less than full prorata. By defining those areas as “excluded areas,” the landlord reduces it absorption of CAM or taxes not paid by those areas. And, again, most typically, the contributions made by those defined excluded areas are deducted from the total allocable expenses prior to calculating the specific tenant’s share of CAM or taxes.

Most typically.

However, there are instances where a lease will read “without deducting contributions from excluded areas” (this is most often seen in the northeast part of the country and Florida). This specific language allows the rare “double dip” by the landlord. It happens infrequently but it does happen.

Occasionally, we’ll see the opposite. Where the previous example includes very specific language that does state “without deducting,” the opposite is often an error. A lease will read something to the effect of “after deducting contributions from Majors,” but the lease does not allow the same Majors’ square footage to de excluded from the denominator. This gives opportunity for the rare “double dip” by the tenant.

One not uncommon issue is where a lease requires Majors or some other defined excluded excluded area to be excluded from the denominator, but subject to a cap on how much square footage may be deducted, or to some certain number of tenants that may be considered excluded areas. For example, a lease may read that “the denominator used to allocate CAM shall be the Gross Leasable Area of the center excluding any tenant greater than 15,000 sf. However, in no event shall the denominator ever be less than 200,000 sf.” In this scenario, if the denominator would have been 175,000 sf after deducting all excluded areas, the landlord would still be required to use 200,000 sf as the denominator. But often, the landlord would have deducted the contributions from all tenants that would have otherwise taken then down to 175,000 sf. In that particular (again, not so uncommon) instance, the landlord would have “overdeducted” contributions.

Our very insightful client recognized that, if not considered, the balance of the tenants would be getting a contribution from an anchor for taxes that they, themselves, were not required to pay.

Why this issue this week? We worked on a property this week where a portion of the property was subject to a material tax abatement. Two of the anchor tenants were required to pay taxes based upon what they would have been absent 50% or 75% of the abatement. So, in this instance, the two tenants were paying on taxes greater than total taxes billed. However, the balance of the tenants did not have the same requirement and were being billed based upon actual taxes. Our very insightful client recognized that, if not considered, the balance of the tenants would be getting a contribution from an anchor for taxes that they, themselves, were not required to pay.

While excluded area contributions are usually straightforward, this is clear evidence that they are not always so!