News

Property Management Systems Can’t Handle This Clause – And if you have them, they will be critical for 2020

We have been seeing a clause for years that is both brilliant and fair to both landlords and tenants – a CAM cap carryforward. The concept is fairly simple. You calculate and apply a cap as required by the lease. However, if there is any excess CAM that the landlord could not bill and collect because of the cap, the landlord can carry that excess forward and bill it if the tenant’s share of CAM in a future year is less than that current year’s cap. (And, as we have addressed in previous blogs, we have to be aware of whether the lease addressed the cap as cumulative or non-cumulative.) Here is an example of what this could mean for 2020 and beyond:

As the example points out, with a CAM cap carryforward, we may be able to pick up amounts not previously billed. And, perhaps even more importantly in the case of a non-cumulative cap, we may be able to prevent the reset to a much lower cap for future years.

This carryforward language is not uncommon. I would venture to say that it exists in about 15% of leases that have cap language. However, it is very landlord-specific, meaning there are numerous landlords out there that use this language while the majority do not. If you are a landlord that does not use this language, keep in mind that it may exist in properties that you have acquired over the years.

And, that blog title, “Property Management Systems Can’t Handle This Clause”? It is true that this is a brilliant, fair clause. However, we have not encountered a “stock” property management system that can handle this clause – tracking the carryforward and applying the carryforward. Please share if yours does.

But, for 2020, and the value of your portfolio, it is worth starting the search and prepping the manual calculations now.

Remember that premises services (utilities/trash) are not common area expenses!

It is not uncommon for a lease to require a tenant to pay quite a few different monthly recurring charges (minimum rent, taxes escrows, CAM escrows or fixed CAM, insurance escrows, perhaps a marketing charge, or storage, or signage to name a few) as well as certain charges to be paid or reconciled annually (those same tax, CAM and insurance charges, percentage rent ). Couple those with so many other clauses that need to be administered for each lease, it is not surprising that landlords try to simplify the administration whenever possible.

One of the more common practices across the industry is to bill certain services provided to tenants for their premises as CAM. In an open air shopping center, these services we see billed most often through CAM include trash removal and water and sewer. Your immediate reaction might be that common area trash and water and sewer for landscaping (hopefully you have separate meters for landscaping so sewer is reduced!) are definitely CAM, and, no doubt, they are.

However, suppose you have just one water main coming in to the center and the tenants do not have individual meters (or maybe some heavy users do). A portion of that water is for the common areas, but a material portion is for water and sewer for the individual tenant premises. That later portion – the water used in each tenants’ leasable areas – in a tenant utility, not a common area expense.

Similarly, premises’ trash is not a common area expense. Yes, we absolutely have common area trash, but if our tenants are using dumpsters that we as landlord pay for the service, that usage is premises’ usage. On the mall side of our business, other expenses treated similarly might also include tenant HVAC (as opposed to mall area HVAC) and, in some cases, electricity.

In most leases (there exceptions even within a center), tenant premises utilities and tenant’s own trash removal services are tenant responsibilities. The tenant is required to pay for these services even if the landlord elects to supply the services.

There are a few reasons you should be thinking about this (you can add your own in the comments as well).

  • If you are billing tenant services through CAM, but competitive centers are either billing the separately or third parties are providing those services, your CAM rates per square foot and your occupancy cost ratio will appear higher.
  • Caps – While the majority of negotiated caps have exceptions from the caps that often include utilities, not all caps have those exceptions, and those exceptions rarely address a service like trash removal or pest control. By billing through CAM, you might be absorbing expenses you don’t have to because of a cap. (Conversely, there is a possibility you may be artificially inflating a cap if these additional services remain flat – but that’s enough for another blog).
  • Denominators/Allocable Square Footage – The square footage provided with these tenant premises services is rarely the same as the square footage used for the CAM denominator, so you might be absorbing expenses for areas not provided with the service. Think about something as simple as trash removal. If you have a 100,000 sf center with a 60,000 sf supermarket that provides its own trash, and the tenants pay CAM on the GLA of the center with no excluded area, billing premises trash as CAM could have you eating 60% of the bill.
  • This final one came up quite a few times over the last few months from different owners – if you convert to a fixed CAM charge or to a gross lease, the tenants are still required to pay those charges (unless otherwise negotiated) because they are not CAM.

We are all for simplification of lease administration whenever possible. However, we never want to oversimplify if it will affect cash flow and value.

Stop – before you grant rent relief! Consider this!

With the number of rent relief amendments we have been processing over the last few months, it is clear that many landlords are trying to work with their tenants so that they can make it through these COVID-impacted times. The most well-respected retail landlords have always considered the tenant mix of their properties. The right balance. The right placement. Asset management decisions are made that, to an outsider, may seem counter-intuitive. But, get it right, and the entire property benefits from increased sales which ultimately results in increased rents. So, for their own health, landlords want to help their tenants survive (and get back to thriving). Therefore, landlords are considering and granting rent deferrals and, to a lesser extent, rent abatements and reductions to help tenants recover.

However, there is one issue that could impact cash flow at a property for years to come as a result of the coronavirus shut downs – non-cumulative caps. If you are in accounting or finance, a light may have just gone on. If you are in leasing or management, you might be inclined to stop reading. But, give me a minute.

If you look at a portfolio of properties, it is extremely common for caps on operating expenses to exist in 50% + of the leases. A cap limits the amount a tenant will have to pay as their share from year to year. There truly is an endless number of ways that a cap can be written, but there are two basic varieties – cumulative and non-cumulative.

For a landlord, if you have to give up a cap, cumulative is what you want. Once you know the initial cap, the actual expenses from year to year will have no impact. The cap increases are independent of the expenses. For example, if I have a lease that states my cap for the first year is $5.00/sf, with the cap increasing by 5% per year thereafter, I can tell you what the cap is going to be in the 5th year ($6.08/sf), or the 10th year ($7.76/sf). The cap allows a tenant to know its maximum exposure down the road.

A non-cumulative cap is impacted by expenses annually. A non-cumulative cap will read something to the effect of “CAM shall not increase by more than 5% over the prior year actual expenses.” Do you see the difference? Unlike in a cumulative cap situation where the increase is applied on the cap itself, in the case of non-cumulative, it is applied on the actual expenses. So, if actual expenses are less than the cap, the cap for the subsequent year – impacting each year thereafter. This materially benefits the tenant over a cumulative cap.

So, in our example, let’s consider that the 5th year is 2020. And, then let’s consider that the property was not operating for 3 months. Perhaps if we were operating for the full year, actual expenses would have been $6.00/sf – still less than what would have been a 5% increase per year. But, because we were shut down, actual expenses for the year come in $4.50/sf. For 2020, we are good. We are less than the cap and we recover 100%. However, in subsequent years, when operations get back to normal, the impact becomes evident.

Let’s say that for 2021, we are back at just $6.00/sf of CAM – no increase over what actual CAM would have been for 2020. With a cumulative cap, we are good. Our cap is $6.38/sf. Actual expenses were $6.00/sf. We recover the full amount. However, with a non-cumulative cap, we have to apply the 5% increase over 2020 actual. 5% on $4.50 is $4.725/sf. That means that we, the landlord, have to absorb $1.275/sf for that year. And, likely each year thereafter.

Your initial thought will likely be that it is not fair or right and that the tenant will understand and the landlord and tenant will take the shutdown into consideration. But, there is absolutely no assurance that will happen. As always, we have to live with the terms of the lease.

However, if landlords consider this now, as they are granting rent relief, this issue can be avoided altogether by addressing this issue as part of an amendment or letter agreement. Something to the effect of the following:

Landlord and tenant acknowledge that tenant has a non-cumulative cap on CAM/Operating Expenses. Landlord and tenant also recognize that, as a result of the impact to the Property by coronavirus, 2020 operating expenses will not reflect a typical year of operations. Therefore, landlord and tenant agree that the cap for 2021 will be 2019 actual expenses increase cumulatively for 2020 and 2021. After 2021, the cap will then revert to the lease required non-cumulative cap for the remainder of the term.

As a general rule of thumb, mom and pop tenants are least likely to have negotiated caps in their leases. Regionals and nationals are most likely to have negotiated caps. And, the better the tenant, the more likely they are to have to have their preferred non-cumulative caps.

As a landlord, you are doing what you can to be fair and help your tenants survive. Don’t let the impact of COVID-19 have unintended consequences.

Looking to the future – dealing with lease related issues

Hopefully, in the next few weeks, we will be slowly but steadily getting back to a new normal. We will all be faced with the question of minimum rents during this period from both the landlord and tenant perspective. But there will be other issues we will all have to consider as we come out of this. We addressed breakpoints in a blog last week – “and the breakpoint shall be likewise abated.

However, there are many other issues we may have to consider. What will the occupancy period be when allocating expenses for the year? Will it remain 366 days, or will we drop it by the number of days we were forced to shut down? What if we were not forced to shut down, but did? What if most of the center shut down, but a few tenants (supermarkets, home improvements, discount superstores) remained open? Do those expenses get allocated across the entire GLA of the center using 366? Do we treat them almost as after hour expenses and allocate them among the tenants that remained open and then use the net occupancy period? What if theaters’ and restaurants’ maximum occupancy loads are reduced to allow for continued social distancing? Do we consider the flat reduction %, or can we consider what the restaurants’ and theaters’ occupancy load was pre-shut down and come off by that much lesser percentage? There are so many more that will come up over the next 12 months as we reconcile all of our leases for 2020. It is better to consider some of these issues now as we start to go through the rent relief exercise so that we do not have to deal with open issues again next year.

Personally, I think we should be fairly optimistic about commercial real estate. The whole country – no, really world – is recognizing that being out and about in a shopping center, mall, office, mixed use property, house of worship, park, greenspace and in any other type of social gathering is preferable to isolation. There will be some continued pain after the fact as we deal with these post-grand re-opening issues. But compared to the pain of isolation and non-operation, that’s a “good” pain.

Two encouraging lessons for commercial real estate from coronavirus

It has been rough for all of us to watch and experience what has been going on in retail over the past few weeks. I was encouraged last week when an International Council of Shopping Center’s friend from Shanghai relayed that retail was picking back up in his city. But, locally – nationally – here, the wait and see hasn’t been easy.

But, there are two really positives coming out of these shutdowns – one objective and one subjective.

Objectively, we have learned the term we have been using in the industry for the past 12-24 months – phantom restaurants – can absolutely work for the future. Absolute proof that a restaurant can succeed without a dine-in presence.  So, those otherwise undesirable, non-fronting or limited-frontage spaces have yet another potential, successful use.

avdining

Subjectively, this pandemic proves that we are all ultimately social creatures. We need interaction with one another. My family and friends will tell you that one of my favorite personal sayings is (jokingly) “I hate people” – only because I am very much an introvert. But, the truth is, (and I am hearing Lyle Lovett’s “I love everybody” as I get ready to type this), I really do truly like almost all people. Even as an introvert, I need social interaction.

So, while we can order so much online, we still need to see and be around people. We need the head nod passing another shopper in the store. We actually need crowds.

And, while every family member and friend I know might complain about the difficulty of finding parking at Avalon, our beautiful, successful mixed use destination in Alpharetta, any one of them would prefer buying their favorite leggings or yoga pants in person at Lululemon than online. They need that social interaction.

We’ll be back after this pause.

I can’t wait to not be able to find a parking spot at Avalon!

1 2 3 9