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FLAT CAM

More big players switch to fixed common-area charges

BY ANNA ROBATON

A continuing switch by leading landlords to fixed common-area maintenance charges is prompting smaller shopping center owners to go the same route. And this seems to have led to a major industrywide change in landlord-tenant relations.

Three years ago the industry watched as General Growth Properties broke ranks by abandoning variable CAM charges, the standard practice at the time for calculating these tenant fees. By going over to the fixed (or flat) CAM side, General Growth was seeking as much to ease tensions with retailers as to lighten its own administrative burdens.

What a difference a few years can make. Since General Growth began charging a predetermined amount to cover occupancy costs, rather than billing for actual expenses, Simon Property Group, North America’s largest mall owner, has followed suit. And many other landlords are either experimenting with leases that incorporate fixed CAM or are pondering the idea.

“I’ve never seen such a significant structural change in the way business is done between landlords and tenants,” said Matthew Ostrower, a Morgan Stanley REIT analyst. “Everyone is dealing with this issue in one shape or form now.”

Though some landlords are still hesitant to change, and though even proponents of the fixed CAM structure say it poses risks for both landlords and tenants, it may be just a matter of time before fixed CAM becomes standard practice.

“Because General Growth and Simon are implementing this so aggressively, there will be pressure to make this an industry standard,” Ostrower said.

The outlook for fixed CAM fees also hinges largely on whether retailers, who have fueled all this by clamoring for more-predictable occupancy costs, continue to demand them.

According to Ostrower, CBL & Associates Properties and Taubman Centers are evaluating the flat CAM structure, while The Macerich Co. has begun using it on an ad hoc basis, primarily at the request of tenants.

Though a Taubman spokesman says the company is “researching the topic,” some insist that Taubman and other landlords that don’t allow tenants to audit CAM charges have less of an incentive to switch, because they aren’t burdened by the hassles and costs associated with audits.

CBL President Stephen D. Lebovitz says his company is still studying the trend, but tending to move in that direction, like most other major mall owners. Macerich declined to comment, and a Simon spokesman said only that company executives have never publicly discussed the issue and consider it a proprietary matter.

On the open-air center side, New Plan Excel Realty Trust is among those that have begun experimenting with fixed CAM, though these landlords face far less pressure than mall owners to re-evaluate their calculation formulas. That’s because operating costs at open-air centers are usually a fraction of those at enclosed malls, where CAM and other costs can account for as much as a third of a tenant’s total occupancy costs.

“We will offer [a fixed CAM lease] to people who request it,” said John Roche, executive vice president and CFO of New York City-based New Plan. “Whether we will make that our standard lease language is not clear.” The firm is proceeding cautiously by limiting the fixed CAM structure to five-year leases.

“The plan is to roll this out with the smaller tenants and see how it goes,” Roche said.

The trend to flat CAM is in fact a 360-degree turn. Flat CAM fees were commonplace, not radical, back when most retail properties were still unenclosed. But as owners started enclosing their properties in the late 1960s and early ’70s, occupancy costs shot up, which was especially troubling for centers saddled with 20-year, flat CAM leases.

Many of those properties fell into disrepair as the rest of the industry shifted to the so-called variable-CAM structure. (With variable CAM, tenants are billed up front, and landlords determine whether tenants have paid too much or too little at the end of the year.)

Leases got shorter, too. Today most run 10 years, and many span just five, making it less risky for landlords to switch back to fixed CAM fees, says Jack Nugent, a director at Meridian Realty Consultants, a Conshohocken, Pa.-based real estate consulting firm specializing in financial due diligence. Further, they are less risky today because landlords have become more sophisticated in their ability to project operating costs.

“As long as the big players that are going to fixed CAM continue to manage their properties as well as they did when CAM was pro rata, the trend will continue,” Nugent said, “and there will be pressure on other large players to go to fixed CAM because tenants like the predictability of it.”

That is expected to result in a significant drop in the number of CAM audits, which has risen since the mid-1990s. Audits are often triggered by year-end adjustments that find tenants have underpaid. On the whole, CAM charges at malls stayed relatively flat over the past decade, as mall renovations and expansions in combination with increasingly expensive insurance and security drove up operating costs.

“You clearly have malls where CAM [charges] have gone up 50 to 100 percent over the last five years,” said Robert A. Machson, principal of Robert A. Machson & Associates, a New York City law firm that handles CAM audits for retailers. “Flat CAM is a solution to the disputes, and that’s laudable.”

Some say flat CAM fees help align the interests of landlords and tenants by increasing the former’s incentive to keep a lid on operating costs — if actual expenses exceed projections, landlords must make up the difference.

“We’ve been forced to project out a little further and make sure we know what costs are going to be going forward,” said Robert A. Michaels, president and COO of General Growth. “It makes us more conscious of the dollars we spend.”

Already, about 40 percent of General Growth’s leases incorporate fixed CAM charges, and the developer expects nearly all of them to do so within 10 years. Its newest properties, including Coral Ridge Mall, near Iowa City, Iowa, and Stonebriar Centre, near Dallas, operate entirely on flat CAM fees.

Michaels notes that General Growth has reaped some administrative cost savings from the change, but he adds that the firm has also found leases are easier to negotiate. “The closer you get to a gross lease, the happier the retailers are going to be, because they can determine all of their costs for the lease term,” he said.

And yet, ironically, most fixed CAM leases are not really “fixed” at all. Rather, they build in regular adjustments for inflation and other increases. What’s more, fixed CAM leases aren’t necessarily cheaper for retailers. In many cases tenants see CAM fees go up when they switch from variable to flat. But they view these higher fees as the price they pay for the ability to predict occupancy costs more accurately.

For landlords, the higher fees and regular increases in CAM rates offer protection against unforeseen rises in operating expenses — larger-than-expected snow removal costs, say. Landlords have also sought to minimize risk by excluding some potentially volatile costs, including utilities, taxes and insurance, from CAM charges and billing tenants separately for them. But, of course, there is no eliminating risk entirely. Inflation can undermine the most carefully calculated projections, forcing landlords to dig deeper into their own pockets to cover expenses, or possibly to defer maintenance.

Furthermore, landlords who implement fixed CAM leases may end up with bigger expenses if vacancies rise unexpectedly, says Ostrower. Under the variable-CAM reimbursement model, landlords hit with unexpected vacancies simply divide their costs over a smaller pool of tenants. Fixed CAM leases don’t allow for that, Ostrower says.

“The question is, does the landlord know what they should be charging to be adequately reimbursed for taking on these risks? There is no way to know until we have a big bout of inflation,” Ostrower said.

For their part, retailers run the risk that actual CAM costs may fall, leaving them stuck with the higher fixed charges. “There is no upside to the retailer if CAM costs should go down,” said Machson.

Machson encourages retailers to audit CAM fees before locking them in, so that they will know exactly what they are agreeing to. “The bankruptcy courts are paved with retailers who have tried to take the easy way out,” he said.

Ultimately, though, flat CAM fees may not be right for every owner or property.

For many landlords, deciding whether to grant these concessions depends on the type of space they are leasing and the clout of the retailer in negotiations.

Some landlords will be reluctant to implement flat CAM at their strongest malls because they have more leverage over retailers there. Yet they may also be reluctant to do so at their weakest ones, where tenants often cannot afford to pay more to help offset the risks. Then, too, the added risk could turn off potential buyers of those assets. Instead of implementing flat CAM fees, owners of these properties are more likely to agree to cap annual CAM fee increases.

“I’ve seen deals fall apart because of fixed CAM being at a property,” said Meridian Realty’s Nugent.

Of course, large national landlords are able to absorb far more risk than the smaller regional owners. And they enjoy the advantage of economies of scale. In the end, even if only a handful of major owners switch to flat CAM, the decision is sure to have a significant impact on the way business is done because of industry consolidation.

“Where there might have been some resistance from landlords in the past, this resistance has come down because of the concentration of ownership,” Nugent said.

Meanwhile, the clamor for change continues, says Gregory Maloney, SCSM, CEO of the Jones Lang LaSalle Retail, a third-party manager that runs about 38 million square feet nationwide. “Today,” he said, “everybody is asking for fixed CAM or caps on CAM [fee increases].”

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