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Owners and tenants seek common ground on CAM

By Kevin Kenyon

C-A-M. Have there ever been three letters with the potential to stir up so much controversy among retailers and developers?

Three letters (standing for common area maintenance) that could possibly derail years of positive relationships among two groups that have always depended heavily on each other, and pit them on opposite sides of a battle that could leave lasting scars on the industry.

In one corner, you have the retailers, some of whom are fed up with what they believe are developers using CAM as a profit center instead of for reimbursement of expenses. They have responded by conducting audits at what some observers believe is an alarming rate.

That's on top of a tax arrangement where smaller retailers usually foot the bill for larger department stores; the former sees the latter getting the equivalent of a free ride. In some, perhaps rare, cases, CAM charges and taxes are eclipsing rent, making it difficult for some retailers to survive.

In the other corner, you have the developers, who view CAM charges as a necessary expense vital to providing the ambience required in today's competitive retail climate.

Many developers are also concerned over the increased use of contingency fee auditors, who are paid according to what they collect, creating a time-consuming situation where landlords are questioned about the smallest of details.

Something has to give.

Because while retailers and developers may be divided on some of the key issues, both sides generally agree on the big picture -- to succeed, retailers need healthy malls and malls need healthy and profitable retailers.

To deal with the problem, retailers and developers alike are looking to address the major issues early on during the drafting of leases, or are considering using all-inclusive leases (gross leases).

Others are looking to establish rules and guidelines for audits to make the process run smoother for all parties involved.

Many developers are also implementing policies specifically geared toward lowering CAM costs, realizing that by doing so, they can better achieve higher rents and keep tenants from bolting to strip centers.

But while some believe positive steps have been taken to bridge the gap, others say it will probably get worse before it gets better.

The growing trend of consolidation among developers, for example, may create a situation where landlords could impose their will on smaller retailers on items such as eliminating audit rights in leases, some industry professionals fear.

The National Retail Tenants Association (NRTA), West Springfield, Mass., a fast-growing group (78 companies) formed in 1996 to help retailers control their utility costs and monitor their pass-through charges, is one organization giving those retailers a voice.

Paul Kinney, NRTA president and director of real estate services for Friendly's Ice Cream, Wilbraham, Mass., said that retailers should have the same option to audit that landlords have to audit a tenant's sales.

"One of the things I think that would absolutely be to everyone's benefit is to allow tenants to audit, rather than always hiding behind the audit clause within a lease. If there's nothing to hide, then people will audit once and only once.

"Landlords have rights to audit my sales. They do it once -- and the reason they do it [only] once is that they don't find anything [amiss]. They'll come back and do it again five years later, and that's fine, that's the way the world runs, but everybody should have the same right," Mr. Kinney said.

The widespread increase in audits is evidence that there are concrete problems that need to be addressed, said Mike Donahue, audit director for Luxottica, the Cincinnati office of the Italian-based company which owns LensCrafters, a mall-based chain with more than 800 stores nationwide.

"No one loves audits, but the proof is borne out by the results," he explained. "It's a simple law of economics: Tenants are not doing more audits because they're not getting money back, tenants are doing more audits because they are getting money back. And the reason they're getting money back must be because of an interpretation of expenses that, in retrospect, were not properly charged."

Tenants can also do their part to improve relationships with landlords, said Mr. Donahue, who serves as secretary for the NRTA. Tenants should be willing, he explained, to give proper notice and work around developers' dates during audits, as well as be up-front about what is being sought.

"Be willing to tell them what you're looking for," he said. "There's a certain fear of the unknown when you're dealing with sensitive data. These are prominent, honest businesses, and they aren't going to change their records to hide things."

Ironically, one of the goals behind the forming of the NRTA, according to Mr. Donahue, was to address concerns of landlords as well as retailers. "We want to make sure that people are looking to audit the important issues, not the trivial issues. Tenants and landlords both need to identify ongoing contentious issues up front in the drafting of the agreement."

The central issue in any audit, Mr. Donahue said, is ensuring that all expenses relate to the common area specifically, and not the entire shopping center. One often-disputed area is the allocation of 100% of a mall manager's salary to CAM, he added.

"The reason they don't call them common area managers is because they are in charge of running the entire mall, so why would 100% of their salary be put into CAM?" Mr. Donahue asked.

"Developers are becoming increasingly resistant to audits," said Charlie Ross, president of Ross Consulting Group, New York, which conducts audits on behalf of retailers.

"Even when we're right, the landlords make you jump through hoops today, which is absolutely not right. In my opinion, it hasn't gotten better, it's gotten worse," Mr. Ross added.

Mr. Ross, who spent 23 years as a retailer for Spencer Gifts, said auditors are not looking to rewrite leases, only to make sure they are being interpreted correctly.

"If we find a mistake, just correct it. Landlords are human, and everybody makes mistakes. All that we're asking is that those mistakes are rectified," he said.

A growing number of landlords are looking to cut audit rights out of leases entirely, said Robert A. Machson, principal of Robert A. Machson & Associates, a New York-based law firm which represents several national tenants in connection with audits.

"The danger that it creates is that as some landlords grow more powerful, they may have far more negotiating power to insist upon what is essentially an unfair provision," he said.

Mr. Machson added that there is a growing concern among retailers over the current situation.

"I think there is a need in this country for a tenant advocacy organization, particularly for specialty retailers. There is an understandable concern about the smaller retailers -- that they don't have sufficient market power to obtain the kinds of terms and treatment to which they are entitled."

A possible solution to help ease the situation is to move toward all-inclusive leases, which would allow developers to make similar profits, but at the same time allow tenants to chart out their costs beforehand, Mr. Machson believes.

The concept of joint audits, in which a number of retailers join together to audit their expenses, may also be the best way to do audits in the future, he added.

Maurie Molod, senior director of real estate, Uno Restaurant Corp., Roxbury, Mass., said that the most important thing a developer can do is put themselves in the retailers' shoes.

CAM and rent are not the only topics of dispute. The tax situation, in which anchors typically pay disproportionately less taxes than specialty tenants, can be problematic for a retailer's existence, he said, adding that a lot has to do with which developer is leasing the space.

"It's a mixed bag. You've got some who are looking at this stuff, trying to keep things under control and are communicating that, and you have others who basically say 'It is in your lease -- pay it and shut up,'" Mr. Molod said.

"There are developers who are proactive when it comes to the landlord/tenant relationship and there are others who are proactive until the ink is dry -- the two are worlds apart."

Mr. Molod, who often travels around the country scouting out sites, said he's found that the cost of building a freestanding store from scratch and operating it is more economical than going into a mall location.

"I can only speak for my company, but I'm better off on the street, and I'm better off on the street hands down," he explained. "It's not even something that's close -- it's something that's light years apart."

Consequently, Mr. Molod said, his company does very few mall deals, largely because of the economics involved with CAM charges and taxes.

In response to tenant concerns, some developers are implementing policies aimed at keeping the reins on CAM charges and opening up the lines of communication.

"It should not be viewed as an adversarial relationship," said Stanley Saddoris, senior vice president, director of operations for Chicago-based General Growth Management Inc. "But I'm sorry to say I think it's come to that because of how some tenants have been treated. It really should be a partnership and that's how we view it."

Concerned about tenants leaving malls, Mr. Saddoris said General Growth has made a concerted effort to keep costs in check. "CAM is necessary to ensure that you have a retail facility that appeals to customers, but you also have an obligation, because the retailers are paying, to give them the best value possible."

To encourage on-site personnel to keep an eye on CAM charges, General Growth motivates mall managers where it means the most -- the wallet -- by basing their bonuses on controlling CAM costs. If managers come in over budget, they get nothing, he explained.

On several occasions, usually lasting from one to three years, General Growth has actually frozen CAM charges, he said, adding that the strategy is another internal device used to motivate on-site personnel. To make sure mall managers don't delay expenses in order to stay under budget, the company also performs mall audits annually, and managers are required to re-bid contracts every two years.

In addition, through General Growth's corporate purchasing program, Mr. Saddoris said the company saves an average of 40% to CAM for supplies, equipment and contracted services. "We try to take advantage of our size [117 malls] to the benefit of the tenant."

As far as audits are concerned, Mr. Saddoris said his company does everything possible to accommodate tenants, including providing them with a summary of information prior to their arrival, giving them pay journals to speed up the process, as well as all the necessary office equipment.

However, General Growth has established a number of rules and guidelines to help the process run smoother. The company requires 30 days' notice, and prefers to do audits between April and November, away from its hectic closing period. The scope and subject matter of the audit is also determined ahead of time. "Because the lease has specific language as to what they can audit, we want to make sure they know what they can audit so they don't waste their time."

Mr. Saddoris also prefers dealing with an auditor working on a fixed fee rather than on contingency. "Contingency auditors hang around looking to find something, and if they don't find something, they'll keep digging."

And while group audits have been touted as methods to save money for all involved, Mr. Saddoris said they can be a "nightmare," citing a case where an auditor read one lease and applied it to all 12 tenants.

"It was a total and complete disaster," he remembered. "Leases vary for each tenant, so needless to say, we spent a lot of time with tenants saying, 'That doesn't apply to your lease.'"

Commenting on the possibility of a developer using leverage to dictate terms to tenants, Mr. Saddoris said that strategy could eventually backfire. "It could happen, and I think that's one of the dangers of getting big, but there are also some benefits to getting big and that is that you can do some things cheaper and faster for your tenants. People who want to use size to benefit themselves will find a way to do it -- until the tenants get wise and refuse to sign leases," he said.

Other owner/managers approach the situation somewhat differently. Unless doing so is specifically called for in the lease, San Diego-based TrizecHahn Centers is not offering audits as a courtesy, said Kurt Sullivan, SCSM, vice president of property management.

"We found that there is a very high usage out there in the industry of contingency fee auditors -- and that has resulted in a tremendous amount of nitpicking on items and a huge amount of time spent by our managers simply going over things that in many cases were quite unreasonable."

That said, Mr. Sullivan added that TrizecHahn makes a conscious effort to discuss CAM issues openly with tenants.

"In the vast majority of cases, that answers the questions," he explained. "I think most people simply want to know what is being done with the money -- the 'why' behind it -- and we're happy to discuss that."

To that end, when TrizecHahn sends out its annual invoice at the beginning of the year detailing what tenants' pre-paid charge will be for the upcoming year, Mr. Sullivan said each manager includes a letter explaining any major shifts in CAM.

"We've found this to be very helpful, and many times results in a follow-up question," he said. Likewise, when CAM is actualized at the end of the year, another letter is sent explaining why CAM expenses came in under or over budget.

In addition, the company seeks efficiencies through group buying, energy management, updating equipment, using consultants, and by negotiating with all contractors annually, Mr. Sullivan explained, adding that these savings are passed on to tenants.

"The best approach is to be communicative and establish a good relationship, because we don't view CAM as a profit center. We would rather get a dollar of rent any day over a dollar of CAM, and we know by controlling CAM costs we have a better opportunity to achieve higher rents."

Another developer which has recently adjusted its policies on CAM charges is The Pyramid Cos., Syracuse, N.Y., according to Mark Congel, a partner in the company.

"What we've done is essentially gone to a fixed CAM number with an annual increase, which has eliminated any interpretation of what it should be or could be," he explained.

By allowing retailers to chart out costs, Mr. Congel said, there is no longer any need for audits or disputes over CAM. "Essentially, CAM charges were an endless pit, and we changed it because it needed to be changed."

At the recently opened Palisades Center in West Nyack, N.Y., Mr. Congel said his company has taken the next step by doing gross rent deals with a pro rata share of taxes, so that each tenant pays its fair share.

So while it's clear that significant strides have been made in bridging the CAM gap between retailers and developers, it's also obvious that this story is far from over, and several key issues still need to be resolved.

Because in a cyclical industry like the shopping center industry, where the landlord is on top one year, and the tenant is on top the next, the winners when the dust settles will be the ones who realize that they can't afford to let three letters come between them.