Caps and Exclusions 

In today’s retail real estate climate, many Tenants (often regardless of size or credit-worthiness) seek to limit the year-over-year increases on common area maintenance costs incurred by Landlord and passed through to the Tenant. For instance, a shopping center Tenant may agree to pay its proportionate share of the Landlord’s common area maintenance costs provided that the cost to the Tenant will not increase by more than 5% per year. This means that although the Landlord’s costs may increase by more than 5%, the Tenant’s obligation is limited to 5% of such increases. Such caps on increases to the common area maintenance costs can, however, have negative impacts on the Tenant by creating a disincentive for the Landlord to maintain the common areas. A savvy Landlord who agrees to these caps will, however, require that certain “uncontrollable” common area maintenance costs be excluded from the limit on increases. Typical exclusions include snow and ice removal, utilities, and insurance costs. The rationale is that while limits on increases may encourage the Landlord to be more efficient, the Landlord has no control over snow removal costs, for example, and Tenants certainly will want to encourage the Landlord to promptly and professionally clear the parking areas and sidewalks of snow and ice.

Capital Improvements 

While many Tenants will resist the inclusion of capital improvements to common areas in the common area maintenance costs for which the Tenant is obligated to pay its proportionate share, it is not uncommon for a Tenant to agree to pay a share of capital improvement costs incurred by Landlord when such improvements are made to enhance the overall operating efficiency of the shopping center. The rationale is that although the Tenant will pay its share of these costs it will also benefit from the efficiencies gained. One way to make a Tenant more comfortable with this cost is to limit the Tenant’s cost-sharing obligation to the extent of savings experienced by the Tenant as a result of the capital improvements. Another creative solution is to amortize the costs of capital improvements.

In a recent lease transaction, we successfully negotiated on behalf of a Landlord client to include parking area repaving and maintenance in the common area maintenance costs. This issue arose as a result of the Landlord’s experience at a different shopping center where repaving and parking area maintenance costs were not included in common area maintenance costs and after undertaking significant repaving measures the Landlord was unable to pass any portion of these costs to the Tenants. At its new shopping center, the Landlord was able to have Tenants agree to pay a share of repaving costs by amortizing such costs over the useful life of the improvement with Tenant paying its proportionate share of the amortized costs on a yearly basis during the lease term. In this case, there were caps on the year-over-year increases for common area maintenance costs, but the repaving and parking area maintenance costs were considered “uncontrollables” and excluded from the cap.

Conclusion

These are just a few creative ways that pro-active Landlords can balance Tenant sensitivities to increases in costs with the need to maintain their shopping centers in a first-class manner and, perhaps most importantly, complete lease deals in a competitive and challenging environment.