View these commercial property management resources that inform on leasing, property financial reporting and other asset management issues. Share your comments and questions.

CAM Calculations

Calculating the CAMs (Common Area Maintenance)

Why is common area maintenance relevant?

Commercial net lease cost recoveries are in the same order of magnitude as the base rent. Given that fact, three things are vital to determining the value of each lease and the property investment returns. Specifically, you need to know what these costs are, how they are calculated and what categories of expenses are legitimately included.

Common area maintenance (CAM) calculations affect:

  • Net lease negotiation
  • Operational and capital budgeting
  • Accounting
  • Property and asset management
  • Property owners
  • Tenants

In truth, there is hardly any aspect of commercial leasing into which common area maintenance costs and recoveries do not consistently factor.

What is common area maintenance?

Common areas are portions of a property that are available to all tenants, a group of tenants, or their invitees. 

It must be remembered that not all of the tenants or their invitees necessarily participate in the use of all common areas. As an illustration, an elevator system in a high-rise building provides no benefit to an outside facing street-level shop. Additionally, the washrooms on each floor of an access-controlled building are only useful to the tenants that use those levels. Under those circumstances, a limited group of tenants, as opposed to the entire rent roll, share in the common area costs.

Common area maintenance costs are the maintenance costs associated with those shared areas. For the purposes of calculating cost recoveries, other maintenance costs that are not for the exclusive use of one tenant are also grouped into the CAM as operating costs. These can include costs associated with the building walls, roof, exterior lighting and climate control systems. Commercial net leases typically list all the permitted and excluded categories of expenses. Unfortunately, most leases do so only in a broad set of terms and do a poor job of providing practical guidance in specific cases.

Can capital costs be recovered?

Often commercial leases exclude capital costs and costs that are capital in nature, from the definition of operating costs. You can read more about capital expenses and proportionate share here. It doesn’t mean that every lease excludes capital costs from recovery. On the contrary, there are other ways in which capital costs are legitimately included in a lease for recovery as an expense.

If capital costs are recoverable, the lease should clearly describe the method for calculating the portion that is recoverable in any one period. Typically, the preference in this case is the straight-line amortization method. It may or may not include interest on the unamortized portion. The lease schedule should include the amortization period for each classification of asset for clarity.

What about reserve funds?

Some property management firms use reserve funds. A reserve fund is money collected from tenants to be set aside for future capital expenditures. Reserve funds deserve a special mention because their deployment and use are often problematic.

Firstly, it is impossible to reconcile their use under normal methods. Obviously, the whole point of the fund is to not reconcile the account balance to the actual expenses every fiscal period. Otherwise, a regular budget and installment payments would work just fine.

Secondly, what determines how and when a fund is used rather than a budget line item? What keeps a reserve fund from being used as a slush fund to make up for sloppy budgeting? Does its designation for a particular purpose like “roof fund” lend enough meaning to keep everyone honest? What level of discretionary use is permissible?

Thirdly, what happens in the sale or acquisition of the building? Does the fund go with the building, or does the fund disappear with the prior owner? Is a reconciliation attempted at that time, notwithstanding the turnover in tenants over the long period?

Fourthly, is there a cap on the fund level or can it accrue indefinitely? Is interest paid into the fund on the balance?

Any indication of the use of reserve funds is certainly worth investigating in a net lease situation.

Cost recovery methods vary

The simplest cost recovery method for a landlord is a bill/rebill method. This works for any expense that is individually determined, such as a service call to a particular location. The landlord gets a bill and invoices the tenant for the amount, usually with an administration or management fee added to it. In the cases where more than one tenant shares costs, a multitude of different factors must be addressed explicitly for each expense.

Where tenants share variable costs over a season or fiscal period, a commercial landlord uses a system of property budgets to prepare for the upcoming expenses and charges instalment payments along with the monthly rent. At the end of the period, the manager performs a reconciliation between the actual expenses and the instalment payments collected for that period. Not all leases on a multi-tenant property will have the same anniversary date. For this reason, setting the budget period for a calendar year rather than a lease term year is typical.

Types of cost allocation calculations

The simplest type of cost allocation is an equal distribution based solely on the number of users. Each tenant pays an equal share. This method can be acceptable where the benefit to each tenant is nearly the same and is largely independent of any other factors. However, a simple equal distribution of the expense does not fairly allocate most expenses.

Commercial net leases use a proportional allocation of expense costs based on the rentable area of the premises. In this method, each tenant’s share is the rentable area of their premises divided by the sum of all the rentable areas. This method isn’t perfect, but it generally more accurately reflects the usage by each tenant and is a predictable and repeatable method for making the CAM cost allocation calculations.

Rentable area and area gross-ups

When using the proportional method for allocating CAM costs, the definition of the areas is vital to making the calculations. The most common standard referenced is the Building Owners & Managers Association (BOMA) standard. This standard has changed over time, and also includes different methodologies for the same class of buildings. It is vital to have the lease specify which standard it uses. Additionally, it is critical to have the lease reference track to the most recent version of the standard. Together, these allow the landlord to use a consistent standard for all property leases. Note that individual tenants cannot specify the standard for all the other tenants. In truth, it is common to find that leases reference different standards for tenants in the same complex.

Buildings with non-rentable common areas will typically have those areas proportionally allocated to the rentable areas. This type of calculated area is known as the grossed-up floor area. For example, the common hallways and washrooms on a particular floor of a building will have their floor area divided up and added to the rentable areas of each of the premises on that floor. Grossing-up areas is a means of allocating those non-rentable areas to the tenants that use them. It is important to note that the gross-up process should consider which group of tenants benefit from the common area that is shared. In other words, each of the common areas may not apply to the same group of tenants every time. There’s a good article here with an overview of how and why to implement gross-ups.

Areas can change over time

Lastly, on the subject of areas, the areas may change over time due to building renovations, area audits that result in changes to stated values, area caps specified in leases and changing measurement standards. Renovations, in particular, can affect not only the related area values but also the user groups if additional or fewer units are made and attach to existing services and common areas. Each of these can force a discontinuity into the fiscal period calculations. Resultantly, another set of calculations is now required using the new data on the effective date of the change.

Expense gross-ups

First, let’s broadly define a few terms for clarity.

Fixed costs are costs that do not vary on occupancy or usage. Examples of fixed costs are utility infrastructure charges like water and wastewater connection charges.

Variable costs are those that vary with occupancy and operations. Following the above example, the amount of water used and the wastewater generated is a direct result of occupancy and operations occurring on a property. Tenants use water for washrooms and lunchrooms when they occupy a space. Site operations like irrigation use water seasonally.

Expense gross-ups reflect variable operating expenses for buildings not fully occupied. Moreover, these may be grossed-up to accurately reflect the portion of the variable costs that are attributable to the occupying tenants.

Slippage is the difference between total property expenses and the amount the landlord can recover from the tenants. Landlords are always trying to minimize slippage, and they do this through the use of expense gross-ups.

Not everything can be grossed-up

Fixed costs are allocated to all of the premises in the user group. Moreover this allocation applies regardless of any vacancies or lease exclusions. These fixed costs that are not recoverable result in slippage. Fixed costs should not be grossed-up to the tenants.

Expenses that should be grossed-up

Operational expenses that are variable with occupancy should be grossed-up to fairly allocate those expenses to the tenants that enjoyed or benefited from them. For example, vacant units don’t use water. It isn’t reasonable to proportionally allocate the water usage portion of the bill to all of the premises if some are unoccupied during that billing period. However, not all variable costs are wholly attributable to occupancy. Even vacant units are heated minimally to prevent water and fire sprinkler pipes from freezing in the winter. Security lighting and building controls still use some electricity. In these cases, reasonable estimates or building information systems may provide reasonable guidance on how much of the expenses should be grossed-up.

Accounting for discontinuities in calculations

We have already mentioned discontinuities in area data that result from changing standards, area audits, renovations and individual lease terms capping allowable changes. These all affect the proportional allocation part of the calculations.

At the same time, variable expenses affect the way the proportional use gross-up calculations are made.

In addition to those factors, leases start and stop mid fiscal periods. Not only does this force a change in allocations to a new tenant, but the leases may also include different, previously negotiated caps and exclusions. What wasn’t recoverable under the previous tenant’s lease may now be recoverable under a new lease and vice-versa.

For all of the above reasons, expenses with billing periods often need to be reduced to per diem amounts and allocated on a daily basis. Certainly, any billing periods spanning the start and end of a fiscal period will need to have adjustments made to allocate the correct amounts to each period. Additionally, any billing period that covers one or more discontinuity events further adds complication. In these cases, the manager will need to proportionally adjust each for the specific date ranges.

How to do common area maintenance calculations

Here are the steps for manually performing CAM calculations:

Step 1

For each invoice, check if it actually is a common area maintenance expense. If it is with respect to at least one lease, check which cost recovery method is applicable.

Step 2

For each class of expenses, determine to which group of tenants the fee applies. At this point, it doesn’t matter if the lease has an exclusion on that particular expense as the denominator requires the total area. Calculate the area gross-ups. If there is a discontinuity in the area values, compile area data for each time period that is at least partially within the relevant fiscal period.

Step 3

Check the expenses to determine whether it is a fixed or variable cost. Undoubtedly, some invoices will have both types on the same invoice. Apply the correct proportional allocation to the fixed costs and calculate the gross-ups for the variable costs based on occupancy. At the end of this step, you should have the correct cost allocation for each of the premises based on the type of expenses and the relevant areas.

Step 4

Using the lease terms, determine if the expense class is eligible for recovery. For example, if the lease states that the roof membrane maintenance is the sole responsibility of the landlord, roof leak repairs aren’t allowed to be charged to that particular tenant even if it is allowed for all the other tenants. This ineligible amount is slippage to the landlord; the remaining tenants do not pay for it. The same process applies if there are limiting caps on cost recoveries for all or some of the common area maintenance and operating expense classifications.

Step 5

Perform per diem calculations for each billing period not fully contained within the fiscal period. Then, do this for each service period that spans a discontinuity in applicable areas, and every time a tenancy change occurs. Equally important, a discontinuity can arise when a period changes within a lease term, for example, at the end of a fixturing period. Often a tenant only pays CAM charges for the property tax and insurance classifications and nothing else during leasehold improvements and fixturing periods of the lease term.

@$%&!, that’s complicated!!

If this all sounds incredibly difficult, you are right. Single-tenant properties and static leases aren’t that difficult to figure out with some experience and reasonable spreadsheet skills. Once the property management company moves into multi-tenant properties and there’s some action with improvements and lease turnovers, it gets tedious and quite difficult to do the calculations correctly. Without doubt, this provides ample employment opportunities for lease analysts and accountants. On the other hand, landlords and property managers benefit greatly from getting it right from the beginning.

The time-consuming approach

One solution for property management firms is to hire lots of people to do the calculations. Let them spend plenty of time doing the calculations as best they know how. Also, hire more staff to review the results. In the end, the reports still have to go out to the tenants. The more sophisticated tenants have staff or consultants to check those reports and perform audits. Even if the reports are vague and don’t contain much verifiable information, there will be several tenants that request an audit of the statements. It’s an expensive and insecure way to run a significant part of the property management business.

The inaccurate approach with slippage

Alternatively, a lot of smaller firms without the available resources give up on making the complex calculations. Consequently, they accept thousands of dollars annually in slippage in what are otherwise legitimately recoverable CAM charges.

The quick, accurate and efficient way

Is there a better way to perform CAM calculations? Yes, there is. CRESSblue commercial property management software has automation systems that perform all those steps and provides an audit trail for each invoice. It’s one of the key reasons we designed it. Our software system also produces the annual reconciliation reports without the need for any math skills or spreadsheets. This is enterprise-level sophistication at an everyday price, far below the cost of doing it any other way. Confidence, efficiency and professionalism are within reach for all commercial property management companies. It’s your time to be ahead.


This article is for informational purposes only and is not intended as professional advice; please consult a competent professional for advice specific to you. This blog is written to stimulate thinking on concepts related to commercial leasing. Please join the discussion with your experiences.

Landord-tenant loans - Risky and difficult or win-win?

Commercial Landlord-Tenant Loans: Yes or No?

Landlords and property management companies don’t often employ commercial landlord-tenant loans during lease negotiations. In our experience, there are five main reasons for this. Here we break them down and investigate their validity. Additionally, we show ways that commercial landlords benefit from providing tenant financing options.

Would you give a tenant financing?

Ask commercial landlords if they would consider giving a tenant a loan to pay for improvements to the leased premises. You are likely to hear one standard response:

“We don’t do loans.”

If you press them further on why they wouldn’t consider financing landlord-tenant loans when negotiating new lease agreements, additional reasons come up. Let’s examine the logic behind the most commonly expressed justifications.

Reason #1: We’re not a bank

This reason is brilliant! Banks take money from clients, pay those clients some interest, and lend it out to other clients for higher interest rates. The banks profit. On the other hand, landlords usually take money as rent and give portions of that money away on various leases as incentives or allowances. In this scenario, landlords do not profit on the dispersed money. Indeed, that is not bank-like behaviour.

Banks make money on everything they offer to clients. So, it isn’t a proud moment for a business owner to give this reason for not doing landlord-tenant loans. To clarify, why would you choose to give money away rather than loan it out at interest? It’s true, your real estate company isn’t a bank. However, there is a compelling case for making loans instead of giving away incentives or allowances.

If cash flow is a concern, consider borrowing against the equity in the building. It is much more likely that a bank will lend a building owner money for property improvements than a tenant who needs business financing to scale up to a new facility. Concurrently, mortgage interest rates for loans secured against real estate are lower than unsecured loan rates. Therefore, it is easier for a landlord to secure financing, and at a lower rate, than it is for a tenant to obtain unsecured credit. This interest rate spread works to the landlord’s advantage. The landlord could not only borrow at a lower rate but also lend to the tenant for a 4-6% interest rate spread. The one-source deal for the property and funding is markedly in the landlord’s favour if the alternative is sending a tenant to their bank for a loan.

Reason #2: We don’t want the risk

Risk of what, exactly?

Without a doubt, loans have a risk factor for defaults. Although this may be true, giving money away is always a 100% loss. It’s a complete write-off every single time. There is no possibility of recovery, full stop.

To be sure, giving away money removes the ongoing risk of default. However, it is very doubtful that the incentive process was designed with this purpose in mind.

As a matter of fact, landlord-tenant loans are far less risky than any other method of getting money to a tenant. A tenant loan comes with a low risk of default. In contrast, an incentive or allowance comes with a complete loss.

Evidently then, the way to remove risk is to secure the loan through the lease agreement and not by explicitly accepting a complete loss from the outset.

Evaluating tenant risk

Every tenant gets evaluated on their creditworthiness when they submit a lease proposal. The financial score factors into two key lease components. Firstly, it impacts the terms and conditions of the lease. Secondly, it affects the qualifying incentive amount. Tenants that have a strong financial showing receive more favourable lease terms, lower rates, and larger incentives. Regardless of how credit or monetary rewards are extended, the same type of financial analysis is performed.

Furthermore, a modified lease agreement is sufficient to secure the tenant loans. In a properly written contract, a tenant cannot walk away from the loan without also losing the premises. This provides additional security to the landlord.

Reason #3: Tenants want free things, not loans

Is there resistance to loans from the tenant side? Obviously, it doesn’t make sense to pursue the loan option if there aren’t tenants willing to take that route. But is this really the case?

Tenants want the premises optimized for their foreseeable business needs. That is the overall objective. Exactly how it is accomplished is another thing. Notwithstanding the fact any tenant would take free incentives over paying for them, it doesn’t preclude using other means to achieve their objectives.

What drives the requests for incentives and allowances?

The need for finances beyond what a tenant can carry at the time of the move drives the requests for incentives and allowances.

Firstly, moving disrupts a tenant’s income stream. Before the move, staff evaluates the amount of space needed and the type of facilities that could improve work processes. During the move, the team faces ongoing disruption from regular routines. Uncertainty slows whatever production is still able to go on. Moreover, the staff still working are doing so without the full strength of the workforce and leadership.

Secondly, equipment is often disconnected and reinstalled in the new premises. This equipment disruption additionally reduces output. All of this is happening at a time when the old facility was already inadequate for production requirements.

Only charities and non-profits work on the business model of getting things for free. Every other for-profit business operates with the assumption they will have to pay for the things they want. What most tenants need isn’t so much getting things for free as the ability to meet financial obligations during a time of reduced cash flow. For this reason, deferring payment for significant expenses during this period of unforeseen costs and low productivity is desirable. Providing financing for a tenant is an acceptable method of easing the transition to the landlord’s building.

Reason #4: We aren’t set up for making loans

Let’s break this down into two parts: internally working out how much to loan and what to finance, and dealing with the loan itself. We’ll investigate the business systems portion of how to deal with the loan in reason #5.

What to finance?

This isn’t really that difficult. As a landlord, you can start with whatever improvements that you might otherwise consider giving as incentives or allowances. As has been noted, loans provide a greater chance of getting your money back than incentives. Owing to that fact, you could consider other work the tenant would want but would be too costly to otherwise capitalize.

For example, perhaps the building really could merit the installation of two additional loading docks. The tenant may not have the cash to do the work now but could benefit from the increased productivity the docks could provide. The landlord may not be certain that the new doors would generate high enough rents in the future to cover the capital cost now if given as a free incentive. A landlord-tenant loan would enable both parties to achieve their objectives now. It’s a win-win situation.

Here is where another real benefit shows up. The tenant loan agreement has created a situation in which the landlord’s building has actually increased in desirability!

Offering a tenant loan creates leasing possibilities that wouldn’t exist otherwise in the world of free incentives and allowances.

How much to finance?

If a property management company is prepared to offer a tenant a loan, how much should it offer to finance? A risk limit was already determined during the review of the tenant’s offer to lease. The financial standing of the tenant and the proposed terms of the lease deal determine the amount of money normally allocated for lease allowances in cash or landlord’s work. Given that incentives would otherwise be given out with no expectation of a return, this amount is easily justified within the existing business decision process.

What about additional work that might otherwise be a capital expense? The landlord-tenant loan is unique in that the landlord has an amazing amount of extra control that a bank doesn’t have.

For one thing, the landlord has control over exactly what will be done. It has the right to examine the scope of work proposed, to approve how it will be done, and what materials will be used. The landlord can choose to finance work that is more generally suitable for the building and its functionality. It can opt for improvements that are likely to generate higher rental rates with subsequent leases.

As discussed in this lease improvements article, the landlord owns all the improvements made to the building. The asset’s value fully secures the loan. The fact that the landlord owns the leaseholds they financed mitigates the risk of loss. Regardless of whether the tenant defaults, the building still has the improvements.

Reason #5: Our business systems don’t support loans

Now that is a problem!

Most business decisions follow the path of least resistance to an acceptable solution. The result is generally a solution that does not deliver optimal results. If perfection takes too much time to work out and implement, then less-than-perfect suddenly becomes acceptable. Any time a business process adds too many steps to a workflow, the best solution will be abandoned for the most practical solution by those required to implement it.

As we have seen, the financial evaluation for landlord-tenant loans is the same process that is used to evaluate any tenant’s creditworthiness. The same types of improvements are available for consideration. However, the value of them can increase due to financing the improvements (rather than writing them off or capitalizing them). Clearly, the case for landlord-tenant loans is solid. On the other hand, considerable resistance exists via property management business systems that don’t support the ability to account for tenant loans.

Ideally, the system would show all aspects of the lease costs in one place:

  • The total cost of improvements
  • The landlord contributions via incentives or allowances
  • The tenant’s contributions
  • The tenant’s down payment on any excess over approved expenditures

Following those records, the business software should have the ability to:

  • Generate a loan amortization table for use as a lease schedule
  • Account for loan payments on the lease invoices
  • Record any extra or lump sum payments and adjust payment schedules
  • Keep track of the loan through any of the tenant, property, lease, and financial records simultaneously
  • Adjust automatically to the lease term dates in case of delays in the lease commencement

Does such an ideal business solution exist? It exists in CRESSblue. Register for your discovery demo today.

Making the case for landlord-tenant loans

Indeed, making loans available really helps smaller companies with limited cash get into a lease agreement. A loan creates possibilities that wouldn’t otherwise exist for both the landlord and the tenant.

Additionally, it can be an easy revenue source for landlords. The legal cost combines into the existing lease agreement setup. It’s a natural source of extra income derived from a property.

A tenant loan offer can significantly lower the amount of incentives a landlord would otherwise give away. Tenants ask for landlord incentives because they don’t have the cash flow or ability to finance the work themselves. Landlord-tenant loans can work out very well for both the landlord and the tenant.

It doesn’t create any extra work in evaluating the loan risk or scope of work. It’s all within the original capabilities and expertise of the persons already making those decisions.

As a property management company, you want your business software systems to support the best business practices. If your systems make the ideal outcomes the easiest outcomes, you will get better results as the default workflow. Limited software systems not only waste efficiency; they also waste opportunities. In contrast, ideal systems create opportunities to allow competitive advantages others cannot match.

Effective leadership is about seeing opportunities and enabling others to seize them. Add landlord-tenant loans to your toolbox and get the business systems in place to implement your new best practices. Make the path of least resistance the optimum outcome.


This article is for informational purposes only and is not intended as professional advice; please consult a competent professional for advice specific to you. This blog is written to stimulate thinking on concepts related to commercial leasing. Please join the discussion with your experiences.

Business Systems: Entry-Level or Enterprise-Level?

So, you’re looking to improve your business systems and discovered there are more commercial property management software options than you thought possible. How does a smart executive choose?

It’s essential to weigh price against capability, workflow and productivity gains. As a result, the most financially efficient system will become obvious. Let’s investigate this in detail.

The common offer

There’s a definite trend towards availability of entry-level software packages for property management. It seems every day another introduction flyer blows into the office announcing the latest and greatest new solution in real estate software. Almost universally, these are the key features:

  • No setup fees
  • Start using right away
  • No user fees
  • No long-term contracts
  • Low monthly fee

If it didn’t mention property management software, one might be inclined to think it was promoting a mobile phone plan. Does commercial property management software actually have the same evaluation criteria as a cell phone plan?

A business system with no setup fees?

Surely that’s a good thing, right?

Maybe not.

Software is expensive to develop. Further, software that does a lot costs a lot. Those development costs need to be recovered somewhere. Setup fees help cover the licencing costs for 3rd party integrated applications like payment portals. They also support the cost of setting up the corporation’s databases, users and accounts. A one-time fee makes more sense in the longer term than paying a blended portion of the upfront development costs indefinitely with every monthly payment.

Unless you plan on changing your software package frequently (like upgrading your cell phone each time), it’s a rather expensive way to access software.

Let’s get going!

Who wants to wait for setup and training? We want to get productivity up right away!

How initial setup affects business systems

The initial setup allows for a significant reduction in workflows due to the automation of tasks that would otherwise be manual. For example, checking invoices against lease document terms can be automated on integrated systems. Similarly, cost allocations can be performed automatically, eliminating the need for time-consuming spreadsheets. Additionally, the reconciliation process can be automated, ending the need for manual reconciliations.

Setup doesn’t have to be difficult or complicated. However, the data needs to be input to allow the system to create the necessary logical structures between the property, lease and financial data sets. These connections allow software automation to take over tedious and time-consuming tasks. Without having the necessary structure in the software, it is impossible to realize significant automation. The system simply doesn’t have enough information to know how to process data for each specific case.

In many cases, large data sets can be set up in the system by using custom import scripts. This is possible when a reliable and accurate data source exists. The scripts map the supplied data into the correct fields in the new database. This setup can save significant time on tedious tasks.

Every advanced skillset requires training and practice. Athletes constantly train and use coaches to teach them and provide feedback. Being good at something requires dedicated education and learning.

Realistic expectations

Facts don’t support the expectation that employee productivity can increase without new systems training. If the system is so simplistic in its capabilities that training isn’t recommended, then there isn’t much hope for increased productivity ever. Alternatively, the system may be sophisticated but without training its users will be continually confused and inefficient in its use.

Training programs teach four important things. Firstly, training programs teach best practices. Secondly, they highlight new and faster workflows. Thirdly, they reveal crucial security procedures. Finally, training programs teach how to use the software most efficiently. This time allows your staff the opportunity to become familiar with the systems and to implement company policies. Providing software training indicates to employees that the company is committed to the system and their use of it.

Providing little or no user training is to accept mediocrity from the outset.

No user fees. Woohoo!

Wait, there are no user roles either?

Business applications need defined user roles. At the very least, the bookkeeping and payment authorization responsibilities need to be separated unless it is a sole proprietorship. Generally, a property management company will need, as a minimum, role segregation in leasing, financial (accounting), asset management (owners) and building maintenance.

Company hierarchy needs to be translated into the software systems and be evident in the user workflows. Approvals should be isolated to those given the authority to make those decisions by the company. The scope of work accessible to a role should be based on the natural flow of information in real life. It’s unlikely your accounts payable person knows that the work done by the maintenance person isn’t recoverable as additional rent for one tenant because of a lease exclusion. If your software isn’t sophisticated enough to do the allocations for you by checking the expense accounts against the lease terms, the lack of capabilities and defined user roles will severely impact the efficiency of your staff. It will drive the workflow outside of the software system.

User roles promote orderly and controllable business operations and decision making. You wouldn’t buy a car with the vehicle controls in the middle for everyone to use at will. Why would you consider critical business systems set up that way?

Defined user roles in business systems are critical for success. They come with scaling fees based on the complexity of the user functions attributed to them. You pay for what you use. We’ll look at fees in more detail below.

No long term contracts?

Ahh yes, the maximum flexibility.

Remember what was said about setup and training? A lack of commitment to a software system doesn’t allow for the realization of any efficiencies either. From the start, effective business systems require setup for automation. Additionally, employees need training to learn effective workflows.

Choosing a property management software system specialized for commercial applications is an important decision. Indeed, it isn’t something you want to do often. It should be a decision that is fully supported by the software supplier. A longer-term contract provides security for your business. Specifically, it assures that your initial investments will have time to pay off. Moreover, a longer-term contract indicates that the software company is committed to supporting and enhancing the system for at least the length of your contract. In contrast, a no-commitment contract lacks these assurances.

Coupled with these benefits, enterprise-level systems typically offer a significantly reduced maintenance rate on user licences for year two and beyond. That is where the real productivity savings make a huge impact.

Business systems with low monthly fees

Surely those are good!

Fixating on the low fees encourages a “price only” evaluation. Frankly, that’s a ridiculous business proposal. If you want to determine value, you need to look at financial efficiency, not just financial cost. What are you getting for your money?

This isn’t the point where you ask for the features sheet.

What you need to see is how the software workflow and abilities improve employee productivity. Are leasehold improvements automatically capitalized to the correct properties? Are the annual depreciation amounts automatically calculated for the accountants? Can an annual additional rent reconciliation be automated without the use of spreadsheets? Is it ready for review in less than two minutes?

We’ve all seen a lease setup done in a demo. Have them show you how the system logic uses that to calculate the additional rent charges and exclusions based on lease periods and negotiated lease terms. Ask for role-specific examples to see the impact on workflows. How is a reconciliation affected by an area audit challenge in a multi-tenant building? Is it an accounting disaster, or merely two minutes of a supervisor’s time before you have new reports for all the tenants and managers? Go way beyond colourful screenshots and best-case scenarios.

The first software demo won’t be able to cover more than the general overview of the system. You will want to have additional demos on specific roles and workflows to assess capabilities and actual outcomes. To that end, you should get a deeper understanding of how you can vitalize your teams on the whole. In like manner, you should be able to visualize better ways to get work done. All in all, you need to see what you can actually accomplish. Don’t settle for anything less than the “that’s exactly right!” feeling.

Realizing efficiency in productivity gains

Can efficiencies be realized in increasing employee output? If you can give your employees additional workload, then the answer is yes. For example, with the right business systems, employees can manage additional properties within the same time frame. Overall, it is reasonable to expect entry-level software to increase employee efficiency by 2-5%. How will you utilize the newfound time and increased efficiency for productivity gains?

The goal isn’t to drive employees harder. Firstly, the goal includes significantly improving the bottom line while reducing tedious work and time required. Secondly, it is to get more accurate and complete accounting. Thirdly, it is to have a happier team. And fourthly, it is to operate a more professional company.

Software systems need to be evaluated based on the impact on actual user roles. Moreover, any found efficiencies need to translate into markedly and measurable increases in productivity. Only then can you make a value assessment linking price to productivity.

Checking the math

Let’s run a quick sample calculation.

In this illustration, we have assumed an average employee salary of $50,000 per year and 50 weeks working, giving a salary amount of $1,000 per week. The results are scalable to whatever pay rate you want to use.

Entry-level software

Entry-level commercial property management software is typically $1 per unit with a minimum of $200 per month. Assuming that this software gives a realized increase in productivity of 5%, we get the following:

ENTRY-LEVEL SOFTWARE PER PERSON PER 4 PEOPLE
Annual Cost  $2,400  $2,400
Monthly Cost  $200  $200
Weekly  $48  $48
Time Savings @5%  2.5 weeks  10 weeks
Savings  $2,500  $10,000
Savings Less Cost  $100  $7,600

We have assumed that there is no limit on the number of users allowed on the system at any one time and that fixed fees apply regardless of the number of users.

Enterprise-level software

Enterprise-level software can conservatively increase productivity by 15% in realized output gains. We have assumed an average combined cost per user of $2,400.

ENTERPRISE-LEVEL SOFTWARE PER PERSON PER 4 PEOPLE
Annual Cost  $ 2,400  $9,600
Monthly Cost  $200  $800
Weekly  $48  $192
Time Savings @15% 7.5 weeks 30 weeks
Savings  $ 7,500  $30,000
Savings Less Cost  $ 5,100  $20,400

We haven’t made any discounts for multi-year contracts.

Comparisons

Enterprise-level software is the clear winner from a business standpoint. Even if you factor in a hefty first-year setup fee into an enterprise-level solution, you still come out ahead when the size of your company dictates you need to move beyond generic accounting software and spreadsheets. Add in multi-year user fee discounts of up to 35%, and without a doubt, the savings are too significant to ignore.

Given these points, it’s not that hard to decide. For example, if you are delivering products, do you want fancy running shoes or a delivery truck? Running shoes are easy, cheap and require little commitment. However, they offer little change in productivity. A truck requires commitment in time, money and operating costs. However, the boost in productivity puts you in another business class entirely.

Investing in a delivery truck serves to break through current limitations. The running shoes can’t come close. Likewise, enterprise-level software supports an optimal workflow and generates maximum productivity. Not surprisingly, marked business growth requires the implementation of correspondingly large business systems.

Decision time!

As can be seen, enterprise-level software systems unquestionably provide the most direct path to commercial success.

The investment in new business systems needs to result in measurable increases in productivity

To that end, here are several key thinking points when evaluating new software systems:

  • What are the current roles in my business structure?
  • Why are the roles defined in those ways?
  • Is the workflow based on the natural flow of information and decision authority, or are they based on the current system process limitations?
  • What are people spending their time on?
  • Where can we save the most time?
  • How much control do we have over the systems we use?
  • Does our work match the processes we use, or does the system define how we do our work?

What defines how we do our work?

Imagine the possibilities if:

  • Your business systems were smart enough to use logic to make repeatable decisions instead of people repeating decisions.
  • Computers did all your math instead of people making and using spreadsheets.
  • Your people did work that let them be thinking humans, and machine systems flawlessly performed the tedious and mundane.
  • Roles supported your people, their abilities, their authority and natural lines of communication – rather than system limitations.
  • Workflows were complete within the software solution.

CRESSblue is designed to require no more interaction for regular tasks than a person would need. So, if a person can describe a complex invoice allocation to another person in 90 seconds, the software can do the same. Or, quicker. As a matter of fact, CRESSblue will also do all the calculations based on internal logic and give you the results, without using employee time. What’s more, you will receive personal support in the initial setup, implementation and training to ensure your success.

We are ready to make a case for the financial efficiency of our commercial property management software system. Moreover, we are happy to demonstrate the clear difference CRESSblue can make for you.


This article is for informational purposes only and is not intended as professional advice; please consult a competent professional for advice specific to you. This blog is written to stimulate thinking on concepts related to commercial leasing. Please join the discussion with your experiences.

Commercial leasehold improvements cost accounting

How are Leasehold Improvements Accounted For?

What are leasehold improvements?

Leasehold improvements are construction that is done to the premises a tenant is leasing to make the space functional for them. Depending on who pays for the improvements and who owns them, there are a variety of legal ways in which the costs are accounted for. Commercial tenants will want to be sure they aren’t paying for them twice.

How do leasehold improvements work?

When a tenant looks at commercial property with the intent to lease the space, there are usually things that they will need to make the space more functional for them. This might include more private offices, additional meeting spaces, separated workspaces in the open warehouse or additional shipping doors. The tenant’s broker will typically insert these into the Offer to Lease under the Landlord’s Work section. Once the landlord gets the offer, they will move many items to the Tenant’s Work section, depending on the future value of the suggested leasehold improvements.

Here is where the first important distinction appears: ownership of the leaseholds isn’t necessarily determined by who pays for the work. Payment of the leasehold improvements is a negotiated deal, but ownership is usually determined by the terms of the lease agreement itself.

Who owns the leasehold improvements?

It might be logical to think that whoever pays for the improvements would own them, but this is usually not the case. Nearly every commercial net lease makes the leasehold improvements the property of the landlord immediately upon completion.

Furthermore, the lease will still require the tenant to maintain the improvements as if they still own them. They do not become the responsibility of the landlord in any way, which includes insurance. The tenant is required to insure the leasehold improvements and to use its insurance to rebuild those improvements if the building is damaged. A lease may even require a tenant to remove or restore parts of the leased premises after the lease term is over, depending on what was negotiated in the lease. It may seem unfair, but leases aren’t inherently fair. Above all, they are an agreement for allocating risk and responsibility in exchange for money and the use of real property.

The 3 ways in which leasehold improvements are paid for

There are three main methods for handling payment of leasehold improvements. None of the three methods is inherently wrong or better than the others.

The first way of handling payment is for the tenant who is leasing the premises to pay directly for all of the work that is done to improve the space. All they seek from the landlord in the lease is the approval of the landlord on their proposed work. The tenant hires the contractors, manage the process and pays for the work. In this case, the rent is based on the premises essentially “as is”, and no account is made for the tenant’s improvements in the base rent number (also called minimum rent).

The second way is for the landlord to provide a monetary incentive to induce the tenant to make a better lease offer, which could involve the tenant doing more Tenant’s Work or staying for a longer term. This inducement amount is either a fixed amount or is given as “X” dollars per square foot to be paid to the tenant to offset the cost of the improvements. Inducements are typically incorporated into the base rent and from that perspective are invisible to the tenant. This is like a cash-back offer, for the reason that the value of the cash back is incorporated into the price. Inducements allow the tenant additional funds when cashflow due to moving disruption can be an issue.

An example of how landlord inducement amounts can be applied over time as illustrated using CRESSblue commercial property management software.

The third way is for the landlord to do the leasehold improvements by doing the work and paying for it. This can be tricky from a tenant’s perspective because the cost of the improvements may be bundled up into the base rent number.

Leasehold improvements are accounted for differently depending on who pays for them

If the tenant pays for the leasehold improvements directly, they are categorized as CCA Class 13 on a Canadian corporate tax return. These improvements are subjected to the half-year rule and are amortized using the straight-line method (meaning the same amount is expensed in each period) over the initial term of the lease.

If the landlord pays an inducement amount to a tenant to offset the costs of the tenant’s work, it is considered income to the tenant. The tenant may use the inducement amount to offset the capitalized costs directly to defer the tax impact. The landlord could treat the inducement amount as a current deduction if it is clearly for the purpose of obtaining that particular tenant, but more likely will amortize the expense over the initial term of the lease.

If the landlord incurs the cost for the leasehold improvements directly and if the costs are of a nature that isn’t specific to a particular tenant, the costs can be capitalized to the building. For tax purposes in Canada, they are then categorized as CCA Class 1, and a declining balance depreciation rate of 4% is used. The base rent is considered only rental income.

What are blended base rents?

If the costs of the improvements are bundled into the base rent and recovered that way without specific disclosure, several things occur.

First of all, the base rent is still treated as income, but part of it is actually a return of capital to the landlord. It would be more accurately described as a rent payment and a loan payment combined. It often seems less confusing to unsophisticated landlords and tenants as it presents only two payment numbers: one for rent and one for the additional rent (or even just one number if it’s the tenant is paying gross rent). The problem for the landlord is that it is paying income tax on money that isn’t really revenue. Concurrently, the problem for the tenant is that it isn’t only paying base rent. Trying to simplify the rent numbers means that the tax treatment isn’t being handled correctly.

Finally, municipal tax rates are set based on the income-earning potential of the property, not the construction cost or the accounting book value of the building. If the cost of the tenant improvements isn’t properly accounted for and ends up in the base rent number, it could cause the property tax values to be higher than they should be. That makes the additional rent higher for the tenant and makes it harder for the landlord to compete in the open leasing market.

How can a tenant end up paying for improvements twice?

If the end of an initial lease term is approaches and the tenant elects to exercise an extension option, the new base rent has to be set. The lease will have language in the lease extension schedule that describes the process for determining how the base rent will be agreed upon. Many leases will have wording to the effect that “… in no case shall the rent be less than the preceding 12 months rent…” On the surface, this may seem fair, since the landlord wants to reduce its risk exposure to rental income loss. However, two important issues are ignored in these words.

The first concerns market value. If the tenant paid for the leaseholds in any way during the initial term, will the new rate be based on the premises as they were before the tenant paid to improve them, or will it be based on what the improved space could get for the landlord now? What exactly is the fair market value based on? If the new rate is based on the market value of the improved space (remembering that the landlord owns the improvements regardless of who paid for them), the tenant will be paying rent to use the improvements it already paid for.

The second issue is that both the landlord and the tenant set themselves up for conflict in the future by making things unclear in the beginning. It can be difficult to know or remember that the rate proportions of base rent and improvement costs were blended initially years earlier. If the repayment portion wasn’t defined at the beginning, it cannot be separated from the rental rate later, and there is no clear way to know what amount it reasonably represented. When it comes time to do the extension, it will be difficult for the tenant to argue convincingly what the base rent floor should actually have been if the number includes other factors rolled into it. In the case of blended base rent and improvement costs, the catchall phrase may actually have the tenant paying for the improvements again in the extended term of the lease.

Even if the tenant isn’t looking to do an extended term, the problem of unclear improvement cost allocation and recovery can show up in an early lease termination. A landlord seeking damages from the tenant will look to recover unamortized leasehold improvement costs and the tenant will not have a clear idea of what it has already paid.

With all the potential issues, why would improvement costs or incentives be rolled up into the base rent?

In addition to simplicity, there is one strong motivating factor. Limiting information in leasing is usually in the landlord’s favour, particularly if the tenant has relatively small bargaining power. It isn’t that every landlord is out trying to take advantage of tenants; it’s simply easier if tenants don’t know what questions to ask and don’t ask any. Keep in mind that leases are contracts and as such the parties can agree to whatever terms they wish – they don’t necessarily have to be fair, just not illegal.

There’s another reason why landlords roll up incentive costs into the base rent, particularly if the incentives allow for a much higher base rent to be set. The building asset value (not the accounting book value) is based on the capitalization (CAP) rate. The CAP rate is the ratio of the net operating income (NOI) to the asset value. If the operating income is inflated by adding in the incentives that are being recovered through the use of an undisclosed blended base rent rate, the value of the building can be artificially inflated above the actual market value based on typical market rents that would otherwise be expected. Some allowance is usually made for undisclosed incentives in the base rent, but large swings from “normal” can influence unsuspecting buyers.

Often the unconscious driving factor behind decisions is the desire to take the path of least resistance to the earliest results. For tenants, it’s the desire to close the deal in an unfamiliar type of negotiation to get on with the move and refocus on their business growth in the new space. For landlords, it’s the desire to limit legal costs and time in negotiation and tenant education, close the deal and start collecting rent.

There isn’t one particular skilled profession that will tackle all the risks associated with the lease deal for the landlord other than the landlord itself. A good broker or lawyer will identify most legal risks on behalf of the tenant, but the future business risks are usually up to the respective parties. Experience is vital for all lease agreements, but especially for identifying risks in negotiation positions when the impact is extended over long periods of time. A specialist lease analyst will have a good working knowledge of a broad range of the professional fields (legal, insurance, financial, construction, leasing and a host of other site specifics). Consequently, they can assist in identifying and proposing solutions to potential lease issues.

Solutions

Commercial lease tenants should insist on clarity in their rent rates. Leasehold improvements cost money and the costs will show up somewhere in the lease terms. Know what they are and where they are included. Have them specifically identified in the lease agreement, including any repayment terms.

Landlords should use systems and procedures to facilitate their record keeping. Therefore, they would use specialized commercial net lease software, such as CRESSblue, with a built-in workflow to do this efficiently and correctly.

Improvement costs and improvements loans, as displayed in commercial property management software.
Clearly recorded and summarized improvement costs and improvements loans, as displayed in CRESSblue software.

The landlord’s process should start with accurately recording the leasing incentives, such as leasehold improvement allowances and construction costs, directly with the lease documents, and tie these to the leased premises in the property records. This allows for documentation to be found in the building history, the lease records, and the tenant records. Invoices should be identified and automatically filed on entry into the records system.

Landlord contributions to the leasehold improvements should be clearly identified. These costs can be automatically classified and added to the building capitalization, with the appropriate depreciation values calculated in a table for the annual tax returns and financial statements.

Amounts to be recovered from the tenant should be treated as a loan to the tenant. Any lump sum payment from the tenant at the lease commencement should be recorded and deducted from the outstanding amount. The balance remaining will then be the loan principle.

Using CRESSblue property management software, the loan terms can be entered and the loan payment schedule will generate automatically. There is a provision to enter extra payments any time throughout the term and the schedule will auto-adjust to reflect these. Furthermore, payment schedules can be tied to the lease period dates to correctly adjust to lease commencement and termination dates.

Efficiently managing a leasehold improvements loan requires easy recording of loan terms and extra payments, and an automatically adjusting payment schedule, such as is offered in CRESSblue.

If the path of least resistance to the quickest results is driving business decisions, it makes sense to use a system that delivers the best results while doing just that. Hence, your software system can enable your team to do the right things with minimal effort. Resultantly, you will consistently have work that is accurate to the highest standard. Book a CRESSblue demo to see how it can empower your business and team.


Disclaimer

This article is for informational purposes only and is not intended as professional advice; please consult a competent professional for advice specific to you. This blog is written to stimulate thinking on concepts related to commercial leasing. Please join the discussion with your experiences.

Commercial net leasing

An Introduction to Commercial Net Leasing & Commercial Lease Software

Why should I be concerned with commercial lease software when it comes to commercial net leasing?

Commercial lease software processes the complexities of commercial net leasing most efficiently and accurately. In this introduction to commercial net leasing, consider the challenges faced by landlords and how property management software makes them easier to overcome.

What is commercial net leasing?

Commercial leases, also known as commercial net leases, are agreements to rent space for business purposes where the rent is net of the operating costs to own and manage the building. There are different types of commercial facilities, with the four broad classifications being office, retail, warehouse and industrial. Often, components of several types are combined in one space, such as industrial with some office and warehouse components. The leases are uniquely tailored to suit the main business use of the tenant in the premises.

Four broad classifications of commercial properties.
Common categories of commercial leasing include office, retail, warehouse and industrial.

What makes commercial net leasing different from renting?

Typically, those new to commercial net leasing are mainly familiar with the concept of residential renting, where tenants pay one monthly rate and are only responsible for separately metered utilities and damages to their rented space. Residential tenants also have an abundance of protections and legal rights.

Commercial lease agreements are nearly the opposite, and this is often a shock to someone who has not been exposed to a commercial net lease. Below are a few of the areas in which commercial leases differ significantly from residential renting.

Legal protections and rights in a commercial lease

Commercial leasing is governed by property law and contract law. A commercial lease agreement is a blend of both of those aspects of law, and gives rights to both the property owner (or landlord) and the tenant renting space (the premises). Certain rights and responsibilities fall under property law and others are under contract law—a complicated distinction which varies by jurisdiction and case law. Protections for the tenant against eviction in the winter, utility disconnects and rent increases do not exist in commercial lease situations like they do for residential rental properties. In addition, rights can be given up in commercial lease agreements that might not be permitted in the case of a residential rental agreement.

What is a net lease?

A net lease, or triple net lease, includes terms describing amounts that will be charged in addition to the rent. The rent shown on the face of the lease agreement is the base (basic or minimum) rent that will be charged. In addition to this, there will be tax, maintenance and insurance charges, collectively called TMI. The maintenance portion may also be called common area maintenance (CAM). There is no real difference between the meaning of net or triple net; both mean the lease has additional charges to the base rent amount that will be described more fully in the lease agreement. These additional charges can total as much as or more than the base rent amounts.

Basic cost components of a net lease.
A commercial lease can include base rent, plus tax, common area maintenance and insurance charges.

The TMI may be classed as operating costs or as additional rent; there’s a slight distinction in those terms and the remedies that can be used to cure a default, with the operating cost being part of contract law and additional rent falling under property law. These vary by jurisdiction, so it’s recommended to consult with a lawyer on those issues and whether it is worth negotiating one way or the other.

In rare cases, a commercial lease may be a gross lease where all charges are wrapped up into one rent payment (as in a residential rental agreement). This is more likely to happen when premises are small and the lease term is short, which can cause difficulty making additional rent calculations. It can also occur when the landlord lacks sophisticated commercial lease software that efficiently performs the required calculations.

What does proportionate share mean?

Commercial sites often have multiple tenants at the same time. In multi-tenant properties, the additional rent is usually allocated to the tenants on a proportionate share based on the rental area of the premises divided by the total rentable area of the building or site.

Commercial lease software takes care of the complexities of expense allocation.
Proportionate share means that tenants pay for actual usage or share of expenses, according to the lease terms.

The expense allocation process can be quite complex when there are multiple buildings on a site, or if not all tenants have access to or use the common areas. For example, a ground floor tenant may not want to be charged for escalator maintenance, or a mall tenant for the common loading docks servicing the stores in another wing of the shopping centre. The operating costs must be properly allocated to those tenants that are in the pool of users of the common areas and services.

In the case of vacancies, a charge called a gross up factor is applied to the shared common utilities that aren’t individually metered, such as central heating and cooling, water usage, cleaning and lighting. Vacant spaces typically have a lower heating/cooling demand (around 30% less) and don’t use water or produce wastewater. The amount of a utility invoice that is based on usage is then allocated to those tenants that are using them for the period covered by the invoice. The fixed charges are still allocated to the entire area connected to the services and that fixed portion of the vacancy cost is borne by the landlord.

Rentable areas of the leased premises may also be grossed up with a proportionate share of the common areas. Base rent will be charged on the grossed up rentable area and not just the rentable area of the premises. This is further complicated when the total rentable area changes on the site or building due to renovations, additions, or temporary construction shutdowns.

Some tenants with high bargaining power can negotiate fixed additional rent rates, or different types of caps on the annual increases in additional rent that will be permitted.

CRESSblue commercial lease software is available to landlords to do proportionate share and date calculations automatically, and can report on the allocations on a per invoice and aggregate annual basis for tenant audits.

Why all the clauses about operating costs?

Commercial leases use similar wording about what is an operating expense (Op Ex) and what is a capital expense (Cap Ex), but the practical application Is quite different. There are no official definitions, and so whatever is in your lease agreement regarding the additional rent will be applicable to your situation.

Generally speaking, operating expenses are those incurred in the maintenance and operation of the building to keep it in its regular state of repair and efficiency. Capital expenses are those that make improvements to the functional ability of the property, significantly extend the life of the asset, or alter its use.

Operating expenses are recovered by the landlord from the tenant(s) through the additional rent charges. Only those expenses that actually occurred are to be charged to the tenant, so this category does not include reserve funds.

Capital expenses are to be capitalized in the landlord’s books and are depreciated. Neither the capitalized cost nor the depreciation is classified as operating costs. That doesn’t mean that capital expenses cannot be included for recovery from a tenant in a lease agreement; it just means that they should not be included in the operating expenses.

The real difficulty for both tenants and landlords is the gray area between Op Ex and Cap Ex. For example, how much of a roof repair constitutes a partial replacement? If 10% of the replacement cost is used as a guideline, can 1/20th of the roof membrane with a lifespan of 20 years be replaced each year as a “preventative maintenance Op Ex”? A landlord could avoid having a major Cap Ex entirely using this approach. Would this method be acceptable if the roof was already leaking? Maybe the tenants would appreciate never having a roof that leaks due to its old age.

One approach or the other isn’t necessarily right or wrong (unless the terms of the lease already dictate otherwise). Landlords will be better off by being transparent in their decision-making process in the terms of the lease rather than relying on ambiguity and a lack of reporting details. Most of the time this isn’t deliberate on the part of landlords; it is a lack of affordable sophisticated software that would allow them to better handle the complex calculations and record keeping. Newer solutions such as CRESSblue commercial lease software have significant capabilities in automating additional rent accounting.

Percentage rents and CPI increases

Leasing space for retail purposes often brings in a type of rent called percentage rent. In retail space like a shopping mall or plaza, the number of visitors to the centre is an important driver in the sales for the tenants. To ensure that the overall performance of the site is reflected in the rents charged to the tenants, there is a minimum rent specified in the lease agreement, and above the break point a certain percentage of the tenant’s sales from the premises is paid to the landlord as rent. The list of tenant products included in the percentage rent categories, the levels of sales and corresponding percentages, and exclusions form a complex negotiation and record keeping challenge.

In highly competitive markets, base rents may also be indexed to the Consumer Price Index (CPI). This allows the landlord to be protected from inflation, and the tenant to know that the rents are adjusted based on an independent third-party. The index to be used, the adjustment periods and the location basis of the index should all be specified in the lease agreement. Wording should also be included in the lease in case the index specified is discontinued, revised or replaced.

Leasehold improvements

Leasehold improvements are at the expense of the tenant. The landlord may offer various incentives to assist either in the construction, payment or financing of the improvements. The landlord will reserve the right to approve the work planned and may also insist that its own contractors be used for portions of the project. This can be for the purposes of maintaining warranty coverages, collective bargaining agreements, or simply because the landlord wants to use contractors it has previously vetted. The landlord may charge fees for having the proposed work reviewed by its architects or engineers.

Once the work is done, the leasehold improvements become the property of the landlord (provided they are not in the nature of trade fixtures, which typically remain in the ownership and control of the tenant). The tenant will be responsible for insuring and maintaining its own leaseholds.

Insurance

The tenant is required to insure its own business, including general liability, as well as its leasehold improvements. The landlord’s insurance is normally secondary to the tenant’s insurance, and does not cover the tenant’s leasehold improvements even if the landlord assumes ownership of them upon completion. The landlord also doesn’t carry insurance for any of the contents in the premises, or for any business interruptions, however caused. It is important for a tenant to review its required coverages based on the terms of the lease, and also to ensure it is fully insured for its own needs.

Annual reconciliations

The additional rent is reconciled annually. A statement is sent out to all of the tenants for each property showing the expenses for the period, the tenant installment payments, and the shortfall or overpayment. The tenant may have certain rights in its lease to review the charges and calculations. There is typically a two year review period for either party to make an appeal or adjustments to the statement.

Why lease?

If commercial leasing is so complicated, why lease at all? Why would someone want to be a landlord or a tenant?

From the owner’s perspective, commercial property is expensive to build and to maintain. Commercial construction costs, property taxes and operating costs are higher than residential rates. It’s very costly to have vacant commercial space sit empty. Becoming a landlord and leasing the space to a tenant can significantly help with those carrying costs.

For a business owner, becoming a tenant can enable access to valuable space in a prime location without taking away from cashflow with a down payment. Having a landlord manage the building allows the tenant to focus on its business strengths without the distractions of building ownership and maintenance. It offers a more predictable way to operate a business, as well as flexibility to move and grow more rapidly.

It’s a business relationship

Lease negotiations are usually handled by commercial real estate brokers on both sides. Often, the actual tenant employees in the premises and the landlord’s property managers are not involved in the negotiation process at all.

It’s important for both sides to realize that commercial leasing is a symbiotic relationship. The landlord relies on the tenant paying rent and looking after the premises as a prudent owner would. Happy tenants stay, which reduces the broker commissions for the landlord, the incentives paid out on new leases and the vacancy rental losses. The tenant relies on the landlord to arrange for maintenance services, pay the taxes and operating bills on time, and to arrange and manage all the various contracts effectively and efficiently. If either party is deficient, the other one suffers as well. They might sit across the table, but both are on the same boat.

Commercial lease software supports good business

Clearly defined terms and expectations, effective communication and transparency are the keys to healthy landlord-tenant relationships. Efficient lease management and reporting is the basis of CRESSblue commercial lease management software.


Disclaimer

This article is for informational purposes only and is not intended as professional advice; please consult a competent professional for advice specific to you. This blog is written to stimulate thinking on concepts related to commercial leasing. Please join the discussion with your experiences.