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FLAT CAM ON RISE

Landlords, tenants seek fewer conflicts

BY DEBRA HAZEL

Tenants pay a flat rate for CAM at the Palisades Center in New York (above) and at Pyramid Cos.’ other malls.

Sick of the distractions and costs of the growing number of audits surrounding common-area maintenance fees, landlords and tenants are increasingly looking to fixed CAM charges as a way to keep the peace — and get back to business.

“There are way too many tenant disputes over CAM issues,” says Daniel Hurwitz, executive vice president at Developers Diversified Realty Corp., which recently began shifting over to fixed CAM charges. “It is not productive to have people discussing maintenance allocations. We need to discuss opening new stores, not insurance.”

In just one example of strained landlord-tenant relations, at press time drugstore chain CVS was in the discovery process in a lawsuit it brought against Taubman Centers that claims the developer has been overcharging on CAM.

To avoid such disputes and ease lease negotiations, many developers are instituting flat CAMs with their new leases. Developers Diversified is one of a number of shopping center owner-managers that are converting their agreements to a pre-negotiated CAM charge with agreed-upon increases added to the rent. Others include General Growth Properties and Westfield America Trust.

The goal is to reduce landlord-tenant tensions and costly, time-consuming audits, which have increased “exponentially,” according to one industry expert.

Developers Diversified began experimenting with fixed versus pro rata CAM in its co-development of the Aspen Grove lifestyle center, which opened in Littleton, Colo., in November 2001, said Hurwitz. Essentially, tenants are charged rent plus a CAM charge that includes nearly all pass-through costs except taxes and that escalates at an agreed rate over the life of the lease.

Beginning next year the company hopes to roll out the idea across its nearly 400-center portfolio, with plans to target its 20 largest tenants first.

“It’s been received very well,” Hurwitz said, noting that there has been a “significant” rise in disputes over CAM, though he declined to quantify it.

CAM and other nonrent costs, such as taxes, can comprise one-third to one-half of a mall retailer’s total occupancy costs, with the highest rates generally being at the more upscale properties. A mid-market mall rent, for example, could total $35 per square foot, with an additional $10 in CAM charges, according to one developer. The 2002 edition of ICSC’s The SCORE: Shopping Center Operations, Revenues and Expenses reports the median rent for nonanchor space at all malls surveyed was $27.47 per square foot, while the median expense recovery (including CAM, utilities, HVAC, security, insurance, taxes and other charges) was $11 per square foot. Add in the CAM administration fee and merchants’ association or marketing funds and the true median occupancy cost is $40.98, the publication says.

For years retailers have argued that far beyond passing along CAM-related costs, developers have used it as a profit center; tenants are increasingly auditing the landlords. With a flat CAM, the tenant knows just how much he’ll be paying, while the landlord saves the time and effort involved in constant renegotiation and audits.

“We love it,” said Lisa Krizek, assistant vice president of leasing at Suffern, N.Y.-based Dress Barn. “It makes life so much easier.” Nearly all the company’s 781 stores are located in shopping centers, and about one-third of its new deals use fixed CAM.

The concept is not new. The Syracuse, N.Y.-based Pyramid Cos., among other developer-managers, has used it for years across its 16-center portfolio.

But fixed CAM charges carry risk for the landlord. Developers could see shortfalls in years with unexpectedly heavy snowfall or an unforeseen expense.

In the 1970s Monumental Properties used a flat charge in its leases and suffered when utility rates soared during the oil crunch, recalls Richard Wolf, CLS, a senior vice president at DJM Asset Management, a Melville, N.Y., real estate brokerage firm. Wolf’s father, Irving, CSM, CMD, was a senior executive at Monumental at the time. (Monumental sold its portfolio in 1978 and is no longer in business.)

To protect itself, the industry developed a new formula, charging first base rent, then percentage rent, and then passing occupancy costs along to tenants on a pro rata basis. If those changed, so did the CAM. And as occupancy at the center changed, so did the CAM, with the costs spread over more or fewer tenants. Formulas became increasingly more complex — and suspicions grew accordingly.

“Some developers went to making money on this, to the point where retailers put in their leases that developers couldn’t charge more than a public utility,” Wolf said.

Ill will was the result all around, perhaps helping along the current revival of fixed costs. With the fixed CAM, the lease becomes much simpler to negotiate. Items beyond the developer’s control, such as taxes or, in some cases, insurance, are still passed through.

“It eliminates that stupid, constant struggle to classify what is reimbursable,” said Melissa Boughton, senior vice president of leasing at Minneapolis-based salon giant Regis Corp., which has signed flat-CAM leases with several landlords. “You don’t have to argue over weather-related costs.”

Regis operates nearly 9,700 salons in multiple formats and under a variety of names worldwide. In North America it operates Regis Salons, Mia & Maxx Hair Studio, MasterCuts and Trade Secret at regional malls.

Other CAM disputes involve personnel allocations, infrastructure maintenance and even holiday decor costs.

General Growth introduced the flat-CAM concept about five years ago in its new projects (SCT, March 2000) and has been actively pursuing the system portfoliowide for the past two years, says President and COO Robert A. Michaels. The company has shifted about 8 to 10 percent of its tenants yearly to the new format, and about 40 percent of its leases are now fixed CAM.

Michaels says he is not daunted by such potential pitfalls of fixed CAM as above-average snowfalls.

“Some years, we probably will have a negative position,” Michaels said. “You have to look at an average of a number of years.”

Some owners say they prefer to negotiate a midlease opportunity to re-examine — and adjust — the CAM increases. Another answer could be to exclude certain items, such as snow removal, from the flat CAM. But that doesn’t hold too well with some retailers.

“It’s flat CAM or it’s not,” Krizek of Dress Barn said.

Flat CAM charges pose potential pitfalls to retailers, too. They run the risk of negotiating the early CAM charge too high. As the numbers compound over 10 years, the last years could see some hefty cumulative charges. “Our only defense is to negotiate a low starting point, or more gradual increase,” Boughton said.

General Growth has begun renegotiating with tenants, even those in midlease, to change their entire portfolio to the new system. But Boughton says she is wary of any portfoliowide CAM, because some developers could use it to negotiate a higher initial rate.

“I’d certainly entertain it,” she said. “But you have to be cautious.”

But for all the perceived benefits of flat CAM charges, not all developers are enthusiastic about the system.

“The way that leases are structured today is most appropriate to our properties,” said Stephen D. Lebovitz, president of CBL & Associates Properties, Chattanooga, Tenn., which has not adopted the flat CAM. “And we haven’t had a big push from retailers to do this.”

One major lease lawyer, too, says he is less than enamored of fixed CAM.

“Most of my clients are not as receptive as one might think,” said Robert Machson, principal of New York City law firm Robert Machson and Associates. About 50 to 60 percent of Machson’s practice is related to CAM issues. “[Developers] set it at a point where they will make money, then add to it.”

Machson is representing CVS in its lawsuit against Taubman. Generally, Machson says, such disputes are settled out of court, but Taubman opted to fight. In July a Michigan court ruled that CVS could examine Taubman’s books, and the retailer is now in the discovery process. Two Taubman motions to dismiss the case have been denied, he adds.

Machson says retailers need to watch out, because developers will set rates based on extreme costs, such as a period of severe weather, even though those events may occur only once over the life of the lease. He advises those who do accept fixed CAM to retain their right to audit and not to accept a fixed increase, but to cap it or base it on the consumer price index, particularly in this low-inflation environment.

“I appreciate the interest in things that move [deals] along,” Machson said. “But I know what happens at the end of the day.”

Several observers note, however, that the fixed CAM should impose even more discipline on managers as they attempt to keep their costs in line with the income they know won’t change. At Pyramid’s Palisades Center, in West Nyack, N.Y., each tenant has its own electricity meter so that usage can be tracked. Some tenants also have their own gas and water meters.

“We’ve tried to make it so they feel they are in more direct control,” said John Mott, general manager of Palisades Center.

One might think that a landlord with a larger, more widespread portfolio, such as a General Growth or Developers Diversified, would be able to balance out the occasional one-year shortfall on one center with lower costs on others. Hurwitz disagrees.

“I don’t think size matters,” he said. “This favors companies that manage their properties in a competent manner. If you take pride in your centers and are efficient, you should be okay.”

Even the retailers’ lawyers like the idea.

“They do like the flat CAM,” Boughton said, “as long as we’re intense about the starting number.”

And even the skeptical Hurwitz says he looks forward to utilizing his legal staff for duties other than audits.

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