Demystifying Additional Rent: What Commercial Tenants Need to Know

For prospective commercial tenants, understanding the terms of a retail lease is essential before signing on the dotted line. One such critical term is Additional Rent, which refers to a tenant’s proportionate share of operating expenses such as common area maintenance (CAM) costs, real estate taxes, and the landlord’s insurance costs. This article explains the different issues to consider when negotiating the Additional Rent provisions of a retail lease.

Firstly, a tenant’s proportionate share is essential when calculating periodic additional rent payments that must be made over the entire lease term. The formula for calculating this share must be agreed on early in the negotiations. Tenants usually want to calculate their share by dividing the gross leasable area of the premises by the gross leasable area of the shopping center. In contrast, landlords may want to calculate the tenant’s proportionate share by dividing the gross leasable area of the premises by the leased and occupied area of the center minus anchors. In mixed-use centers, factoring in office or residential users further complicates the calculation. When negotiating tenant’s proportionate share, it’s crucial to ensure that shopping centers tied together under a larger project that is governed by a reciprocal easement agreement (REA) do not create an unfair allocation of costs and expenses to the tenant.

Secondly, retail leases usually include a definition of CAM costs and specifically list what costs the landlord can pass through to the tenant. From the tenant’s perspective, certain costs such as capital expenditures or building related improvements should not be passed through to the tenant because the tenant does not directly benefit from these costs. The tenant should agree to pay for a portion of the landlord’s capital expenditures if they are required by law or result in a material increase in the efficiency of the building or its systems. However, the tenant should never agree to pay for capital expenditures that are tantamount to construction or development costs. Landlords often charge their tenants for administrative and management fees, which should be carefully examined and negotiated to ensure that the landlord is not charging a fee tied to gross rents.

Thirdly, tenants often try to minimize their exposure to excessive costs by negotiating a cap on the CAM costs that the landlord can pass through. A tenant’s proportionate share of taxes and insurance costs is not typically capped because, in theory, they are outside of the landlord’s control.  Caps on CAM costs can be done in several ways, such as capping the amount that the tenant’s proportionate share of CAM costs may increase annually.  The tenant may also impose a specific dollar limit on the CAM payment made for capital expenditures.

However, negotiating a cap on CAM costs can be a challenging task as landlords typically want to ensure that they are able to recover their costs and maintain the property in good condition.  Here are five negotiation challenges that tenants may encounter when negotiating a cap on CAM costs and potential solutions:

1. The landlord may argue that a cap on CAM costs will limit their ability to maintain and improve the property. One solution is to propose a cap that allows for reasonable increases to cover inflation or unexpected expenses, but still provides the tenant with some cost certainty.

2. The landlord may want to include a clause that allows for increases in CAM costs if the property is sold or refinanced. Tenants can negotiate to limit the scope of such increases or to require the landlord to provide documentation to support the increase.

3. The landlord may not want to include a cap on certain types of expenses, such as utilities or security. Tenants can propose a cap that includes all CAM costs, but allows for certain expenses to be excluded if they are outside of the landlord’s control.

4. The landlord may propose a cap that is too high or does not adequately protect the tenant from excessive expenses. Tenants can conduct research to determine what is reasonable for the specific property and propose a cap that aligns with industry standards.

5. The landlord may resist the idea of a cap on CAM costs altogether. Tenants can propose other solutions, such as an auditing clause that allows for the tenant to review the landlord’s CAM expenses or a requirement for the landlord to provide regular reports on CAM costs to ensure transparency.

In addition to capping the amount that the tenant’s proportionate share of CAM costs may increase annually, there are other ways to negotiate a cap on CAM costs. For example, tenants may also impose a specific dollar limit on the CAM payment made for capital expenditures. This means that the tenant would not be responsible for any expenses related to major capital improvements, such as the replacement of an HVAC system or a roof repair, beyond a certain amount. By negotiating a cap on CAM costs, tenants can avoid unexpected expenses and better manage their overall occupancy costs.

In conclusion, retail leases are frequently net leases where the tenant pays their proportionate share of operating expenses, referred to as additional rent. Negotiating the terms of additional rent provisions can be complex, and tenants must ensure they understand the terms they are agreeing to before signing on the dotted line. A clear understanding of the formula for calculating a tenant’s proportionate share, the definition of CAM costs, and the cap on CAM costs can save tenants significant costs in the long run. Overall, prospective commercial tenants should always consult with their legal team before signing any lease agreements to ensure that their interests are protected.