Thursday, October 29, 2015
9:00 AM – 10:15 AM
Workshop 9: Everyone Into the Pool:
Allocating Expenses among Diverse Occupants of Mixed Use Projects
Presented to
2015 U.S. Shopping Center Law Conference
JW Marriott Desert Ridge Resort & Spa
Phoenix, Arizona
October 28-31, 2015
by:
Kathleen D. Boyle
Of Counsel
Pircher, Nichols & Meeks
900 N. Michigan Avenue, Suite 1000
Chicago, IL 60611
[email protected]
Mindy C. Novack
Vice President, Real Estate Legal
Hudson’s Bay Company
th
th
12 East 49 St., 18 Fl.
New York, NY 10017
[email protected]
EVERYONE INTO THE POOL:
ALLOCATING EXPENSES AMONG DIVERSE OCCUPANTS OF MIXED USE PROJECTS
ICSC 2015
Workshop 9
I. Introduction
Operating expense pools allocate operating expenses among tenants and other occupants of multi-tenant
buildings, shopping centers, office complexes and mixed use developments. This Workshop will focus on the various
methods of allocating CAM, tax and insurance expenses among the occupants of mixed use centers. We will address
the promises and perils in structuring and amending cost allocations for developments that are mixed use from
inception or that are converting from single to mixed use – whether traditional regional centers or urban in-fill – and
consider the use of pools to divide types of expenses among groups of users. We also discuss how the phasing of
projects over several years affects the allocation of operating and certain capital expenses among all users in a mixed
use development.
Questions arise in droves when considering how to allocate expenses into coherent pools. For example, let’s
consider the shopping center component of a mixed use development. Is the retail component a regional mall or a
strip center? Grocery anchored? Is the retail use intermingled with office uses, such as next door to each other, or
are such uses divisible? Does it have lifestyle components with more outdoor access and amenities than an interiororiented center? Are there outparcels? Are there anchor stores? Is the retail component solely on the first floor of a
high rise office building? How many owners of the development are there and do they own separate portions? All of
these questions affect the creation and operation of expense pools.
In order to address operating expense pools, we first must consider the history of operating expense
allocations and compare the practices of in-line and anchor retail, restaurant, entertainment, hotel, office and
residential users based on their historical practices in allocating expenses. We also must consider what operating
costs are actually passed through to tenants in the first place before the occupants of any mixed use development can
proceed to the next step of allocating those costs among occupants. We consider special circumstances, such as the
practices of anchor stores and outparcels, and how those practices affects operating expense pools. For urban infill
projects, we touch upon the use of vertical subdivisions or condominiums to bring some clarity to operating expense
allocations. We examine the movement to fixed operating costs and the pros and cons of “fixed CAM” allocations for
operating expense pools in mixed use developments. Finally, we address the importance of communication, with
landlords needing to provide detailed calculations and back-up for its operating expense allocations even if the
landlord/owner’s motivation is only for the practical reason of reducing the exercise of tenant audit rights.
In this article we often refer to tenants and occupants and to owner/landlords and to leases and allocation
agreements. The reason for this is that mixed use developments often plan for separate ownership of parcels – and it
is often the parcels with different uses that become separately owned. Therefore mixed use developments include
owner/occupants who also share in operating expenses and may become members of operating expense pools for
outparcels. Although part of an operating expense pool with tenants, the owner occupants’ responsibility for paying its
share of operating agreements arises not by leases but by separate agreements such as reciprocal easement
agreements, operating agreements or cost allocation agreements (collectively, “REAs”). Potential gaps can occur in
expense allocations between leases and REAs that are often not discovered until a prospective buyer conducts due
diligence. For example, if the lease allocates property taxes based on a floor area calculation and the REA for the
development provides that each parcel owner pays real estate taxes on its parcel, the landlord/owner on whose tax
parcels the leases are in place may have to cover the differential to the extent taxes on common areas are not fully
covered by common area operating expense allocations.
Mixed use projects have an added complication of often being developed in phases. Sometimes this is
triggered by market demand, sometimes by issues such as financing. Building in phases creates site work cost
allocation issues: do future phase occupants share in phase 1 site work and do phase 1 occupants share site work
costs for future phases? If expanding vertically, site work includes “support work” allocations, the additional
construction costs of making a building suitable for adding more floors. Perhaps the next phase should pay a portion
of those costs. This also treads on the push-pull between owners and occupants regarding pass-throughs of capital
expenses, which we discuss in more detail below.
II. HISTORICAL PERSPECTIVE
Operating expense pools are often referred to as “CAM pools”, with the term “CAM” being an acronym for
“Common Area Maintenance”. “CAM” initially covered just that – each tenant’s or occupant’s pro rata share of both
interior and exterior common area maintenance expenses such as removing snow and cleaning, sweeping and
maintaining sidewalks, hallways, parking lots, shared trash areas and other common areas. Capital expenses were
usually borne by the owner/landlord. Particularly in the retail context, tenants would argue that CAM has since grown
into a pass-through by landlords to tenants of almost every cost of operating the development, including some capital
expenses that in the past would be considered a cost of ownership, not an operating cost. Customary exclusions are
often limited to such items as landlord’s debt service, management office costs, leasing commissions and costs, and
tenant allowances. Tenants and occupants are becoming sensitive to what might be referred to as “CAM creep”,
resulting in heavy negotiations in leases and operating agreements. These negotiations encompass both exclusions
from operating expenses and what categories of expenses should remain with the landlord/owner as an ownership
cost, never rising to the level of an expense to be passed through or an exclusion from such expenses. Because
expense allocations nowadays actually involve more comprehensive operating expense allocations between owners
and occupants, the pools (or buckets) of expenses described in this workshop have moved beyond CAM and are
more appropriately called “operating expense pools”. However, strictly for ease of reference, from time to time we will
use the informal shorthand term and call such pools “CAM pools” even though operating expenses that are passed
through to occupants of a development encompass far more than mere common area maintenance expenses.
As part of the historical perspective, drafters also must be aware of the differences in styles of leases that
have become customary over the years for the different uses that comprise a mixed use development. Different types
of tenants use different services and their share of services is calculated differently. This means that both the
owner/landlord and tenants in a specific category of user may want to create a pool that is applicable only to that type
of tenant. This enables the landlord and tenant to compare “apples to apples” and provides clarity in the allocation of
operating expenses.
An example of the need to differentiate by use of services is an office building with the two lowest floors being
retail. Office tenants will receive janitorial services or elevator services not used by the retail portion of the building.
Retail tenants will use HVAC and electricity services for longer hours than office users and use more water than office
tenants, particularly if there is a restaurant. This makes it likely that a fair allocation of those operating expenses
would be to create separate pools for the office users and retail users.
Industry standards for the method of determining pro rata share differ among different users. Office leases are
often structured as modified gross leases in which tenants pay only their proportionate share of operating expenses,
insurance and taxes over the amount of such expenses incurred in a “base year”. The “base year” is usually the
calendar year or fiscal year in which the lease term commences, with some variations for taxes depending on how a
development’s jurisdiction assesses taxes. Office leases use a load factor to determine tenant’s share in the first
place, allocating a certain percentage of the common area to the floor area of the premises. This is not done in retail.
Office leases also handle allocation of expenses with regard to vacant spaces differently than retail – they gross up
the variable expenses rather than deduct unoccupied space from the denominator, as we discuss in more detail
below. Office leases generally assign a fixed percentage to each space, including the load factor.
Retail leases, on the other hand, are traditionally structured as triple net leases with tenants paying their
proportionate share of property taxes, insurance and common area operating expenses in addition to base rent.
Unlike office leases, retail leases create a floating percentage of each premises’ operating expense allocation that
varies based on the amount of unoccupied space and other types of uses that are deducted from the denominator:
anchor stores, kiosks, restaurants, storage space, management offices – and in enclosed malls, the outparcels and
other space that is not fronting on the enclosed mall, whether or not such space is on a separate tax parcel.
One way to accommodate these different industry standards of allocations is to base the operating expense
pools on “equitable”, “reasonable” or “good faith” allocations. Another option may be to have a cap on the percentage
of costs allocated from one use as compared to the other, which is discussed in more detail below. However, such
caps can create a problem if the use within a project changes. In our example, how would the allocations be affected
if retail would also move to all or a portion of the third floor? Potentially the pool would have to change.
III. ACCOUNTING CONSIDERATIONS
CAM allocations can become a morass of line items on a spread sheet, and lawyers would be wise to work
with their accountant and lease administrator counterparts when drafting or revising shopping center operating cost
allocations. Most lawyers are not accountants so may not understand that accountants may have a more nuanced
view of an expense that does the lawyer. For example, allocation of capital expenses may be of particular interest to
accountants as they evaluate potential pass-throughs of capital expenses, since whether such expenses can be
passed through or not creates significant ramifications as properties age. Also, the accountant should review the
proposed language for pass-throughs and exclusions to catch discrepancies from common accounting principles
(such as GAAP, if GAAP is used as a standard) and any changes in tax treatment of expenses.
As a practical matter, if the lawyer is preparing a new lease or allocation agreement that will be used in
conjunction with existing accounting or lease administration software, the users might want to take a little extra time to
mesh the allocation language to the software (or at least not be contradictory) to save time for lease administrators
going forward. Lawyers are on the same team as the accountants and lease administrators and should seek not only
to understand the landlord or tenant client’s perspective about operating expense allocations, but to convert the
concepts into an understandable and usable lease or allocation agreement. Such insight may also enable lawyers to
avoid endless negotiations over a single line item on a ledger that has limited impact financially.
IV. OVERVIEW OF OPERATING EXPENSE POOLS
In converting operating expense allocations into reasonable pools, owners/landlords, tenants and other
occupants must divide their negotiations into two steps: First, what expenses of operating the building or development
can be passed through to tenants or occupants, and second, how such costs should be allocated among all of the
tenants or occupants into pools. The bulk of these materials focuses on the second element, the allocation of
operating expenses among tenants and occupants into pools, but to do so we also need to discuss the basics of the
first step – what constitutes operating expenses appropriately passed through to tenants. This will be addressed in
the next section. However, before working backwards to the initial negotiation about what expenses can be passed
through, let’s consider the principles underlying operating expense pools, as the end negotiation regarding the pools
themselves can also provide insight into that first negotiation – and decisions made in the first negotiation impact the
final allocations into pools.
We discussed the traditional differences in types of leases for different categories of users and their effect on
allocations, but let’s dig a little deeper into the underlying concepts. In both theory and practice, allocations of costs
into expense pools should be made based on one of two general parameters depending on the type of expense in
question. The first parameter is an allocation based on which tenants or occupants cause the expenses to be
incurred, usually by the tenant’s existence in a certain space (location) and potentially by its activities. This type of
pool focuses on what causes resources to be used or consumed. For example, a heavy user of electricity may be
required to pay a higher proportion of electrical utility costs based on use (even if not separately metered) than other
users in its pool whose electrical costs are allocated solely on the basis of the GLA of each of their premises.
The second parameter focuses on who gets the benefit of the cost incurred. This type of allocation may have
little to do with the location of an occupant within the development, but rather on its specific operations. For example,
an advertising promotion may be of benefit to a certain retailer or group of retailers but of no use to an office tenant
next door. The elevator and janitorial services used by office occupants as discussed above is another example.
Given that expense pools group together expenses that are reconciled in a similar way using the same parameters, a
mixed use development that is spread out over many acres and involves several types of uses is likely to have many
different operating expense pools with different groupings of participants.
V. DETERMINATION OF OPERATING EXPENSES
Before parties can begin to allocate expense pools they must determine and agree upon what expenses
constitute CAM or operating expenses that should be allocated to tenants and other occupants. As mentioned above,
this is one of the most heavily negotiated provisions in the lease or allocation agreement. Although we will not
address this topic in detail, understand that a traditional approach to address operating cost pass-throughs is that
landlords want to “pass-through” as many costs as possible, while tenants will look for a comprehensive list of
exclusions from operating expenses, or, even better for the tenant, have an expense not even make the list of passthroughs at all. For example, aggressive tenants or tenants with significant market power may attempt to limit
operating expense pass-throughs to a specific set of items on a list rather than accept the landlord/owner’s broad list
and try to negotiate exclusions. Some classic examples include the following:
 Capital expenses include replacements for structural components of a building or additions, renovations or other
improvements that increase the value of the center. Capital expenses are supposed to be distinguished from
expenses for the day to day operations at the property, but there is limited consensus on where to draw the line.
For example, is parking lot repaving excludable as a capital expense or is it simply a maintenance expense?
What expenses for building improvements belong to landlord and what can be passed through to tenant? What
about those site work improvements for the new development mentioned above? Can costs for maintenance,
repair and replacement of the roof be passed through to the tenants operating under that roof? If both sides
agree that an item is a capitalized expense for which tenants should pay an amortized portion, what period of
amortization is used? Should the parties amortize the capital expense over the useful life of the item or some
other number, such as straight line amortization over the initial term of the lease or even a lesser period? Does it
matter if a capital expense lowers operating costs for tenants – should that capital expense be passed through?
 Insurance deductibles – Insurance premiums are expected to be passed through to tenants, but what about
deductibles? If a tenant is willing to pay deductibles in the event claims are made, should the cost be amortized?
 Advertising and promotional fees – Should these expenses belong to the development or be passed through to
tenants, and if passed through, how should the allocation be made? Should some tenants pay a higher share
than others or should costs be passed through simply based on square footage?
 Landscaping – should replacements of trees be passed through to tenants? What if landscaping improvements
only affect a portion of the center?
Whether an expense is fixed or variable could affect both the allocation and its scope. Some expenses, such
as insurance covering the common areas of a mixed use development, are fixed costs that can be reasonably
allocated on a square footage basis among all tenants, based on the assumption that all of the tenants at the center
generally use and rely upon the common areas in the same way. However, a tenant or occupant in one corner of the
development may object to that allocation using the argument that it makes limited use of the common areas. If the
development carries significant cachet in the market, this type of argument might easily be pushed aside.
Utilities are a classic variable expense. Although utility usage in the common areas (particularly electricity)
benefits all tenants and therefore can reasonably be passed through on a square footage basis, how should utility
consumption in a tenant’s premises be handled? What if a computer store uses a lot of electricity but a clothing
retailer only uses electricity to keep the lights on and run its cash registers? Should there be an allocation based on
consumption of a utility? Obviously the first choice would be to sub-meter each tenant space, but that is not always
feasible. Therefore landlords often calculate the costs of utilities and allocate them on a per square foot basis. This
use of square footage can hurt tenants that enter the development after the heavy-user tenant, as the language in the
heavy-user tenant’s lease may not force the heavy user to pay more than the usual square footage allocation. This
leaves the new tenant potentially subsidizing the heavy user.
In addition to fixed or variable expenses, accountants on the team also refer to controllable and noncontrollable expenses. Controllable expenses are expenses that result from operating and maintaining the building or
shopping center. An example of a controllable expense is landscape maintenance. Some accountants and tenants
may also argue that common area utility usage is a controllable expense even though it varies by the weather. Their
argument is that the owner/landlord can take measures to improve efficiency for utility use, just like tenant want such
owner to be encouraged to be efficient regarding landscape maintenance. Non-controllable expenses, on the other
hand, are expenses that arise unexpectedly due to breakdowns and failures of the building due to external factors
rather than maintenance failures. An example of a non-controllable expense is the expense of snow removal, as
landlord cannot control the weather.
Some tenants may attempt to negotiate caps on expenses the tenant is required to pay. This often occurs
with those expenses deemed controllable. The theory is that landlords need an incentive to minimize controllable
expenses and to efficiently manage the property. However, some tenants attempt to cap property taxes, over which
landlord has less control even if a landlord protests taxes every time that option is available. The owner/landlord must
decide if agreeing to the cap for a particular tenant is worth the headache if taxes increase more than a cap.
In addition to individual leases, caps can be used to limit expenses being paid by tenants in an expense pool
(such as one building) or for only one or a few expenses in that pool. Caps can be placed on one or more expenses
on a gross basis (before allocation among tenants) or on a net basis (after allocation among tenants in the pool).
Caps can be described using a cost per square foot number or a percentage or an absolute dollar amount. Although
outside the scope of this article, caps can also be cumulative (landlord-preferred) or non-cumulative (tenant-preferred)
in several variations.
Another issue for owner/landlords and tenants is allocating fixed and variable expenses when a building or a
shopping center is not fully occupied. Fixed expenses are easily handled as they do not vary with occupancy, so each
occupant pays its proportionate share of fixed expenses and the landlord/owner absorbs the cost attributable to
vacant spaces. When variable expenses are allocated within buildings or developments with significant vacancies,
however, there is risk of unfairness to both the owner/landlord and the occupant unless there is some sort of gross-up
of those variable expenses. This term is more fair than it sounds, as it avoids tenants (primarily office tenants) from
being overcharged for operating expenses if there is significant vacancy in a building or shopping center. Shopping
centers customarily address this issue by placing a floor on the denominator, such as not permitting the denominator
to be less than 70% of the gross leaseable area of the building or the shopping center (less those portions of the
building or center that do not belong in the particular calculation. This method is not perfectly accurate but serves the
practical purpose of being much better than doing nothing. For office occupants, the custom is to “gross up” the
operating expenses to those that an occupant would be paying if the building was fully occupied. This is when the
lawyer may happily defer to the accountant to determine the appropriate methodology for deciding what the operating
costs would have been if the building was fully occupied using standards suggested by the Building Owners and
Managers Association (BOMA), for example.
VI. PROPERTY TAXES AND POOLS.
Although property taxes are generally calculated and billed separately from other operating expenses, the
allocation of such expenses also require pools that may be different from pools for other operating expenses. Tenants
who operate on their own tax parcel are excluded from the allocation of taxes among shopping center tenants and pay
their tax bill directly to the taxing authority. The payments of those anchor tenants who benefit from a tax cap is also
deducted from the denominator. One discrepancy that should be accounted for is that property taxes on retail uses
are usually higher on a per square foot basis than for office uses. This is another reason why developers may want to
segregate pools of office users from pools of retail users for purposes of allocating such expenses.
When planning or expanding mixed use developments, developers must consider if they want to blend the
pool across several tax parcels or if the pools should be on a parcel to parcel basis, as different parcels may have
different assessments due to past use such that two tenants with the same use may be paying different assessments
solely due to the parcel’s prior use. This problem does not occur in every state but causes developers to consider
larger geographic pools for property taxes.
One difficulty in developing mixed use projects is planning for separate ownership of parcels – and it is often
the parcels with different uses that become separately owned. How many tax parcels should a developer create at the
beginning of the project? At the same time developers want to lease up their projects no matter what portions get
peeled off later under separate ownership. Because of that uncertainty, there is a continuing tug of war between a
developer/landlord’s desire for flexibility and the tenant’s or occupant’s desire for control of its premises and
surroundings. In setting up pools the developer often must make a best guess based on the information available at
the time the developer must establish pools.
VII. SPECIAL CONSIDERATIONS FOR URBAN INFILL PROJECTS
Urban infill projects often solve the tax and operating expense allocation problem by recognizing and
accepting the layers of ownership that can occur with high dollar value projects. A residential condominium structure
might govern the residential portion of the development, and then that residential condominium’s association is a
member of a high rise mixed use development that is itself structured as a condominium. When structuring such a
development, the drafters will want to have someone with expertise in leasing review the condominium documents, as
lawyers who specialize in condominium law may not be familiar with the requirements that tenants have with respect
to many leasing issues, including cost allocations, just as many real estate transactional attorneys are not conversant
with condominium statutes. Perhaps the condominium declaration should be the primary vehicle to address cost
allocation among condominium members and the operation of the building itself. The REA can then be used for
issues that impact the tenants of the development by addressing operating expense allocations that ultimately flow
through to the tenants.
The same sort of arrangement works with air rights subdivisions, so whether to utilize air rights subdivisions or
condominiums is to a large extent guided by state law, and certainly not differences in operating expense procedures
or allocations.
Not only changes in use but changes in the density mix of a project can affect carefully crafted expense pools.
Those changes in density can be triggered by market conditions or driven by the entitlements process. However,
urban infill by its nature has less flexibility to change density due to parking constraints, use limitations, and of course,
space limitations, so that is a lesser risk than for a low rise mixed use development that can spread out
geographically.
VIII. EXPANSIONS AND CONTRACTIONS OF THE DEVELOPMENT
Besides thinking about passing along pure allocation of costs into operating expense pools, lawyers must also
consider the importance of having consistent lease or cost allocation agreement forms among their different pools.
This issue comes up in casualty or condemnation provisions. For example, the members of a pool, particularly a pool
based on location, will want similar triggers for lease termination rights in the event of casualty. Otherwise the
landlord/owner risks a “doughnut effect” if important tenants or groups of tenants are able to terminate their leases in
the event of casualty on different terms than their neighbors. Although not strictly an operating expense issue,
rebuilding a development after a casualty is also affected if there are differing provisions regarding use of insurance
proceeds. Issues like these highlight the importance of consistency in crafting leases and related agreements for
reasons beyond ease of administration.
Drafting for expansions might be considered the flip side of thinking about consistency for contractions, as the
owner/landlord wants to preserve its flexibility not only with respect to what can be built, but how the pools for
operating expenses might change. Should a developer negotiate to permit expansions of pools (perhaps by having
the ability to change key definitions, such as the definition of a shopping center)? Might a pool be expanded to
accommodate the expansion or would an agreement effectively force an owner to create an entire new set of pools?
Are there some instances in which existing occupants want to be placed with the new development; particularly if
there are lower operating expenses on the newer developments that in turn reduce existing costs? Tenants will be on
the look-out for fairness and want to avoid subsidizing the new entrants to the center. Information sharing will be a
practical challenge that might be placed on the negotiating table by savvy parties.
IX. PARKING ISSUES
Creating expense pools for parking in mixed use developments often falls short of truly equitable allocations.
Residential occupants want exclusive parking for the residential units. Hotel operators may want valet services, as do
restaurants, and valet services may also be an amenity that is available throughout the development, particularly an
urban in-fill project. Developers may want to be the sole provider of valet services instead of permitting individual
occupants to have valet rights. Retail users, particularly anchor stores, are concerned about poaching by office users
who might otherwise have to pay higher office parking rates. Other occupants will be concerned about the impact on
parking of entertainment or restaurant users such as restaurants, theaters and health clubs. Under these
circumstances, simple allocations of parking expenses based on GLA may be inadequate.
The expectation of occupants is that any revenue generated from parking lots or parking services would be
credited against operational expenses. Occupants will also question who should pay for a share of the costs of
devices to regulate parking, such as key card access, separate entrances, free or validated parking for a limited time.
Some occupants try to exclude from their share the cost of operating parking decks so that they do not subsidize the
benefits that may disproportionately affect other occupants. Drawing the line between what is considered a nonreimbursable capital expense and maintenance expenses is another factor. An occupant may refuse to pay a
proportionate share of parking lot resurfacing except for once every certain number of years, for example, but will pay
patching and related maintenance when incurred.
Employee parking is a common issue affecting the occupants’ day-to-day operations. If a set of occupants
have the employee parking zone close to their premises, should those occupants be participants in a pool whose
parking maintenance expenses are lower than their neighbors? What happens if employees violate the parking rules
and park in spaces that might be used by an occupant’s customers? Should there be a penalty? As to the employee
parking areas themselves, should the cost of maintaining those areas be attributed to the occupants, perhaps on a per
square foot basis using the size of each premises, or a method reflecting the number of employees working for an
occupant?
A sometimes overlapping issue is the allocation of the expenses of a parking deck, as some employee parking
might be located on the less desirable portions of a deck. Is the appropriate method of allocating operating costs
based on which occupants receive the benefits of that deck, or should the allocation be based solely on location?
Some tenants take an initial stance of refusing to pay any operating expense allocation for a deck. Is that a viable
position for that development? Disagreements regarding the allocation of parking operating expenses result in some
of the testiest negotiations – and often after the lease or cost allocation agreement is signed. The parties may not
become aware of practical considerations until after the development is in use.
X. SPECIAL USES: ANCHOR STORES, ENTERTAINMENT, OUTPARCELS AND HOTELS
Operating expenses are customarily allocated by dividing the gross leaseable area (“GLA”) of a tenant’s or
occupant’s premises by the total GLA of the portion of the development in the operating expense pool (sometimes
including a gross-up)– for example, the main building of a regional mall or the occupants of the main building of a strip
center. However, many nuances come into play. For example, the anchor store occupants in a regional mall or a strip
center generally do not pay their full pro-rata share of operating costs, but instead pay “fixed CAM”, a dollar amount
per square foot of GLA of their premises. When this happens, the amount paid by such anchor tenant is generally
removed from the CAM equation, particularly for retail, by deducting the GLA of the anchor store premises from the
GLA of the shopping center, that is, the denominator is reduced. The fixed CAM amount paid by the anchor tenants to
the landlord is then deducted from the amount of landlord’s operating expenses attributed to that particular operating
expense pool before the costs are allocated among those occupants in the portion of the development that is subject
to that pool.
Outparcel tenants or occupants customarily pay their own operating costs for their parcel because the
outparcels are often separate tax parcels and separate buildings with their own utility meters. Perhaps the outparcel
owners will pay a charge for maintenance and use of the ring road or other access to the development that is
separately calculated and paid, creating a mini-CAM pool with like outparcels. In any event, if an outparcel’s
expenses are separately calculated, that outparcel’s GLA is also removed from the denominator for determining the
CAM allocation for that expense pool, and the amounts paid by the outparcel occupant to the owner/landlord for CAM
expenses, if anything, is deducted from landlord’s CAM costs to be allocated among the occupants and tenants in that
particular pool.
Hotels are often located on outparcels that have been sold or ground leased to the hotel operator. Therefore
they often have separate tax parcels and self-contained parking, making the analysis for outparcels apply to hotels as
well. If a hotel is part of a mixed use high rise development, the operating expenses are similar to the other occupants
of the high rise, with the operating costs attributable to the ground level lobby and its designated elevator bays
attributed to the hotel.
Restaurants and entertainment venues, such as theaters, may have at least some expenses appropriately
removed from general retail pools due to the longer hours of such uses and the specifics of their use. For example,
restaurants and theaters remain open at night and require additional lighting, both interior and exterior, and security,
all of which should be absorbed by that user. Restaurants also make greater use of shared trash facilities so should
bear an appropriate proportionate share of such costs. Some landlords and other occupants require outdoor patios
for restaurants to be counted in the development’s GLA when calculating expense allocations unless the restaurant is
on an outparcel and can be removed from the calculation all together.
XI. AUDIT RIGHTS AND TRANSPARENCY
Operating expense pools for mixed use developments involve complex allocations and nuanced definitions.
Tenants react to this complexity by requiring audit rights of the owner/landlord’s books and records for the
development (or perhaps applicable portion of the development) so that they can verify that the items designated in
their leases or allocation agreements as being included or excluded from operating expenses have been correctly
performed according to the parties’ agreements. Landlords are becoming willing to accept that audit right, provided
that certain limitations are followed. For example, landlords want a limited time period for a tenant or occupant to
conduct the audit after receipt of the operating expense statement from landlord. Landlords usually want to preclude
contingent-fee auditors in favor of certified public accountants or the tenant’s own in-house accountants and want to
limit the number of audits per year to no more than one. Another reasonable limitation is that the tenant may perform
audits for a particular time period only once, and the audit results must be confidential. A common provision is to
have landlord pick up the costs of a tenant audit if the audit discovers that the tenant has overpaid operating expenses
for a lease year by a certain percentage, such as three percent. The tenant’s or occupant’s audit right should have the
effect of encouraging landlord/owners to provide statements that provide reasonable detail of the expenses and their
calculations, broken down into a clear, readable, understandable format. Heading off an audit by providing sufficient
detail and transparency promotes efficiency and saves the landlord/owner money and aggravation.
XII. FIXED CAM
Perhaps retail landlords and tenants wore each other out about twenty years ago. Since then the concept of
“fixed CAM” has moved into real estate portfolios. Fixed CAM combines a fixed initial amount with a predetermined
rate of increase. As with CAM pools or operating expense pools, fixed CAM can encompass all costs of occupancy,
including promotional costs, insurance, those capitalized expenses that are passed through, and even property taxes,
or it can be limited to traditional CAM. Of course, this means that the initial CAM charge is the most heavily negotiated
issue, as it is the base amount for all future increases and is the actual charge for the first lease year. The push-pull
over what to include or exclude in an operating expense pass-through remains the same. The landlord wants to have
a cushion to protect itself from unanticipated (or poorly estimated) costs, while the tenant wants to get as close to what
it would have paid under pro rata CAM as possible. ( Sometimes the parties agree to re-set the number after a period
of years to guard against such issues.)
The advantage to fixed CAM is that it helps tenants who want predictable operating costs more than the
accuracy that pro rata CAM can provide. The usual stated advantage of fixed CAM is that it reduces audit disputes,
which is generally true, and that is a significant plus for large landlords. A hybrid of fixed CAM carves out the
uncontrollable costs, such as snow removal, from fixed CAM. Although this means that a tenant will likely want to
audit those uncontrollable costs, it narrows the scope of that investigation.
Fixed CAM has been used successfully in mixed use developments in which it would be difficult to attribute
correctly CAM costs for a smaller set of users due to the differences in lease types and custom. For example, fixed
CAM may be the most graceful solution for a set of first floor retail tenants in an office high rise. Although fixed CAM
opponents raise the specter of reduced maintenance of developments as owner/landlords’ budgets tighten, it remains
a reasonable alternative that can save negotiating time.
CONCLUSION
Given that mixed use developments may change many times through all of the phases of the development,
the lawyer for the developer/owner will want to consult with the owner on what plans the owner has to make changes
in the near future, as any such changes are likely to impact operating expense allocation. It is necessary to determine
how much flexibility a developer needs to implement future development plans so that the development is not locked
into leases that fail to anticipate future changes that will affect operating expense pools. For existing centers, the
owner’s attorney will also want to think about whether the client is acting with a short-term or long-term perspective. Is
the client interested in completing a major redevelopment over ten years or more, or is the client interested in buying
the center and beefing up occupancy, then cashing out relatively quickly? On the tenant/occupant side, is the
occupant’s anticipated period of occupancy ten years or more, or is the client a start-up in-line tenant with limited
bargaining power? Representation of the parties in mixed use developments requires a constant balancing act of
determining how much time (and legal costs and potential negotiating delay) should be expended to negotiate the
flexibility a developer is looking for or the control a tenant wishes to have. By comparing the perspectives of in-line
and anchor retail, restaurant, entertainment, hotel, office and residential users based on their historical practices in
allocating expenses, we hope to give context as lawyers consider how those perspectives can be melded into
expense allocation pool provisions that each user will accept and perhaps even come to appreciate.