Tag Archive for: CAM

CAM Slippage and how to avoid it.

What are CAMs and How to Avoid CAM Slippage

What are CAMs?

Before we dig into CAM slippage, let’s get clear on exactly what CAMs are. CAM stands for common area maintenance. Property managers of multi-tenant office, retail, industrial and warehouse properties typically use net leases. Such net leases recover from the tenants the operating costs for shared common areas separately from the base or minimum rent. These operating costs for shared common areas are the “net” portion of the lease. They include taxes, maintenance and insurance (TMI) that cover the property and building, as well as other overhead expenses and depreciation. CAM (again, the common area maintenance) is part of this TMI (though CAM is sometimes used to refer to TMI). While CAM costs are primarily operational expenses, portions of capital expenses are sometimes also recovered from tenants. The total cost recoveries are often referred to as Additional Rent in the lease agreement.  

What is CAM slippage?

Slippage is the difference between the total operating cost of the property and the amount recovered from tenants. It represents the often-preventable losses incurred from various sources. What causes CAM slippage, and how can you avoid those losses?

There are two broad causes of CAM slippage: voluntary and involuntary. Surprisingly, much of the slippage occurs directly from voluntary actions on the part of the property manager. We will look at the voluntary reasons first.

Voluntary reasons you’re experiencing CAM slippage

1. Going over budget

Ideally, as a property manager, you want to hit your property budget exactly. That way, the annual reconciliation statement and accompanying invoice for the shortfall in their instalment payments won’t surprise your tenants. Property managers may look for ways to avoid confrontation when budgets exceed targets by large amounts. They may simply elect to not recover the excess over the instalment payments. In other cases, annual reconciliations remain incomplete. This often occurs for leases that use a Base Year of CAM expenses to determine the annual additional rent that will be typical for the lease term. While provisions are included in the lease to recover any costs in excess of the base year, very often no reconciliations are made. Leases that use a base year for additional rent invite lazy property management behaviour that is costly. 

So why are budgets missed?

  • No budget was made. More accurately, no budget planning was done at all.
  • Budget items were missed. It’s relatively easy to miss an expense item, even if you normally incur that expense. This type of error is easily introduced when using spreadsheets; all it takes is a missed cell in a formula calculation range.

Solution

Use software that automatically builds a property budget based on previous expenses for that property. The entire budgeting process is greatly simplified, no previous expense items are missed, and no calculation errors are possible. There is no need to avoid budget excess embarrassment and take a voluntary hit on CAM recoveries.

2. Unallocated costs

Annual reconciliations of additional rent are supposed to determine the difference between the actual expenses incurred and the tenant instalment payments estimated in the property budget. So how do reconciliations expose the property manager to slippage?

Quite simply, if the expense allocations are only looked at annually, it can be difficult to figure out what the invoices are for and who should be paying for the expense. Typical examples are:

  • Service invoices without a service address. This is especially problematic when a contractor provides services at more than one property. Where was the service performed? Which property does it apply to?
  • Invoices with mismatched data. What happens with an invoice where the tenant name and the service address aren’t consistent? Which is correct?
  • Invoices where the services description is not clear, and it cannot be determined if the cost recovery is allowed under the terms of the lease(s).
A service invoice with errors that may result in incorrect tenant billing and CAM slippage
Above is one example of a real-life invoicing error. The service tenant name and address are incorrect at the top, while the correct tenant unit number shows in the description area. How likely is it that the wrong tenant would have been billed for the service call? Had the property manager entered it into the system right away, this error could have been corrected quickly. Instead, the tenant may eventually dispute it, and it will be difficult to correctly sort out months from now.

In cases like these, property management companies often take voluntary slippage on sloppy paperwork or lose out on disallowed expense claims as a result of a tenant’s expense audit.

Solution

Cost allocations should be made when the bill is entered into the Accounts Payable ledger. That is when the memories are still fresh. Moreover, vendors will correct the bills so that the information is clear before payment is made.

3. Difficult CAM breakdown calculations

While the base rent is a relatively straightforward calculation, the CAM allocations are anything but. We’ve previously covered the complexity in another article. Typical complications are variable expense gross-ups, partial expense periods due to lease commencement and expiry, area gross-ups and rentable area changes.

When the CAM allocations are very complex, property managers often use low-ball estimates to include a “safe” amount of the expense in the CAM statement “that will surely be acceptable” to the tenant as it is obviously below the correct amount.

Solution

Our CRESSblue team finds these types of voluntary slippage decisions frequently. Interestingly, the slippage amount is often more than the annual cost of using software to automatically do the calculations. Your property management software solution should do the math for you without requiring spreadsheets or calculators.

Involuntary reasons you’re suffering from CAM slippage

4. Missed expenses

Simply missing expenses for recovery as additional rent is a type of involuntary slippage. Indeed, this easily occurs when the property management system does not tie invoices to properties. Recurring transactions are relatively easy to track, but one-off expenses are easy to miss in manual spreadsheet-based systems.

Credit card receipts are good candidates for accidentally missed expenses. They typically do not have enough information to identify the items and do not include a service address or a tenant name. The receipts end up being overhead expenses rather than additional rent. Also, they often get lost.

Solution

Firstly, make sure billing is detailed enough to serve as a receipt that can stand up to audit scrutiny. Use commercial vendor accounts that require additional information such as the service address and full descriptions of the items and services purchased. Secondly, use a property management software solution that requires categorizing the expenses at the time of entry. As a result, this makes it impossible to pay a bill and forget to recover the expense. CRESSblue has both a simple-to-use system for allocating costs and an automatic rebilling function for direct expense recovery from a tenant.

5. Lease language

Leases often contain language that lease administrators don’t actually understand. As a result, they never utilize and realize the benefits of many of the lease document’s negotiated terms.

Grossing-up of variable costs

A frequently occurring example of this is when the additional rent allows for the variable costs to be grossed-up to account for disproportionate usage when the subject property is not fully occupied:

In computing Operating Costs, if less than one hundred percent (100%) of the Rentable Area of the Property is completed or occupied during any period for which a computation must be made, the amount of Operating Costs will be increased by the amount of the additional costs determined by the Landlord, acting reasonably, that would have been incurred had one hundred percent (100%) of the Rentable Area of the Property been completed or occupied during that period, provided that, for greater certainty, it is confirmed that in no event shall the Tenant’s Proportionate Share of Operating Costs be increased pursuant to this section beyond the amount that would be payable if the Property had been fully rented.

Even though most commercial leases contain similar language for the same effect, administrators often do not separately track the variable expense portions. Moreover, no accounting is made to recover these costs solely from the occupied areas. As a result, they are allocated to unleased portions of the building as vacancy expenses when, in fact, they are legitimately recoverable from the tenants using those services and utilities.

Expense caps

Negotiators often use complicated verbal formulas and expense caps to reach some consensus on what an equitable distribution of costs should look like. Essentially this is a trust issue. The tenant does not believe that clear documentation is available to them to ascertain the costs’ correct calculation. However, very often, the documentation that enables the use of the lease formula is missing. Indeed, consider this example:

The Tenant’s proportionate share of the operating costs that are under the Landlord’s control shall not exceed 105% of the payment for such costs the previous year.

This statement requires that the landlord track the operating costs under its control separately from those that are not. One would suppose that those not under the landlord’s control would be realty taxes and property insurance. There are numerous ambiguities with that clause. Does “such cost” include only the similar costs year after year? To put it another way, how do you handle an additional required service that isn’t in the prior year’s basket of costs? Alternatively, what if a union strike unilaterally forces wage increases on the landlord above the 5% increase limit? Are those included in the cap as well?

Solution

Without reservation, negotiate lease terms from a practical standpoint. When the labour to track and calculate the amounts cost more than the additional rent recovered, you may incur losses negotiating for extra rent. Use lease administration software that automatically tracks and recovers, or limits the recoveries. Lease abstracts don’t include boilerplate lease terms. So, they can slip by unnoticed. Your software solution should have the accounting logic and mathematical ability to conform to your lease agreements’ terms.

6. Asset tracking

While similar to the lease language issue, this one deserves a separate mention due to the solution’s scope and the large cost recoveries that it implies. The language included in the typical lease definition of the operating costs look like this:

… depreciation or amortization of any capital repairs and/or replacements made by the Landlord to the Property and or Premises, …

What does the inclusion of this language imply? Asset tracking. Capital repairs and replacements are added to the property’s asset value and amortized over that equipment’s expected lifetime. The landlord needs to track those assets and calculate the amortization to add the depreciation and amortization to the tenant’s operating costs recoveries. The tenant in this lease expects charges for capital costs made for or during its own tenancy, but not for those associated with the previous tenants. Are those costs significant enough to warrant the effort to track and calculate the depreciation and amortization expenses? For a rooftop HVAC unit, installed costs of $15,000 over a 15-year lifecycle would amount to a straight-line depreciation cost of $1,000 per year that could be recovered.

Solution

Use a property management software system with asset tracking that can automatically invoice for the amortization expenses permitted in the terms of the lease agreement on the monthly rent invoice.

Property management solutions

Evidently, CAM slippage is easy to incur both voluntarily and involuntarily. Specialized commercial property management software can significantly improve these situations. Is the software expensive to licence? Not at all in comparison to the CAM slippage costs. In fact, using dedicated software can increase profitability. Also, it provides peace-of-mind with clear documentation and accurate calculations.

Likely, active leases are not alterable. However, you can take action to implement the current agreements’ terms. Additionally, understanding how to fully realize lease clauses’ implications enables you to better negotiate for future leases. What is holding you back from being better?

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.

Martin Sommer, CEO, CRESS Inc.

Follow me on LinkedIn

Martin is a founder and the CEO of CRESS Inc., a Canadian SaaS company that automates lease administration and asset management. Martin also manages Karanda Properties Limited industrial portfolio as Director of Operations in all areas of commercial property management, including new development, asset management, capital expenditures, operations, leasing and lease administration of the industrial portfolio. Martin writes about property management workflow and issues. Book Martin to speak at your industry event.

CAM Calculations for commercial property managers.

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.

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.

Martin Sommer, CEO, CRESS Inc.

Follow me on LinkedIn

Martin is a founder and the CEO of CRESS Inc., a Canadian SaaS company that automates lease administration and asset management. Martin also manages Karanda Properties Limited industrial portfolio as Director of Operations in all areas of commercial property management, including new development, asset management, capital expenditures, operations, leasing and lease administration of the industrial portfolio. Martin writes about property management workflow and issues. Book Martin to speak at your industry event.