How to Ensure Tenants Will Pay Your Entire Insurance Cost
Your shopping center leases probably require each tenant to pay its share of the center's fire insurance, liability insurance, and other kinds of insurance.
However, if you want to pass through your insurance costs to your tenants as a separate component of CAM costs solely by using a standard formula based on “gross leasable area,” you may have a problem. That is, if your leases base each tenant's share of your insurance costs on a percentage of the center's gross leasable area, but your anchor tenants carry their own insurance, you will not get reimbursed in full for your insurance costs. As a result, you could get stuck paying the shortfall.
With the help of New York City attorney Gary A. Goodman and commercial leasing consultant Richard F. Muhlebach, we will explain in more detail how that can happen. And to help you protect your wallet, we will tell you how to properly calculate each tenant's share of your insurance costs properly so you are not stuck footing the bill for those costs. Further, to ensure that you will get paid, we will give you a Model Lease Clause (see p. 3) to put in a nonanchor tenant's lease, and Model Lease Language (see p. 4) to put in your anchor tenant's lease.
How Standard Formula Works
Your leases probably use this standard formula based on gross leasable area (GLA) to determine the tenant's share of insurance costs:
Owner's insurance cost x (tenant's area ÷ GLA)
Example: Your center has a GLA of 100,000 square feet. You pay $50,000 for insurance on the buildings in your center. Half of the GLA is occupied by a 50,000 square-foot anchor tenant supermarket. Occupying the remaining 50,000 square feet are a 20,000 square-foot drugstore and three small 10,000 square-foot stores. Under the standard formula, you would figure the annual contribution for each of the four nonanchor tenants in these five steps:
Step #1: Calculate the drugstore's share: $50,000 insurance cost x (20,000 sq. ft. ÷ 100,000 sq. ft) = $10,000.
Step #2: Calculate the smaller stores' share: $50,000 insurance cost x (10,000 sq. ft. ÷ 100,000 sq. ft) x 3 (number of 10,000 square-foot stores) = $15,000.
Step #3: Add the results of steps #1 and #2 together: The four nonanchor tenants would contribute $25,000 ($10,000 from the drugstore and $15,000 from the three smaller stores).
Step #4: Calculate the anchor tenant's share: $50,000 insurance cost x (50,000 sq. ft. ÷ 100,000 sq. ft) = $25,000.
Step #5: Add the results of steps #3 and #4 together: The five tenants would contribute a total of $50,000 ($25,000 + $25,000), which covers your entire insurance cost.
But there is a problem with those calculations: In reality, all five tenants may not contribute.
Problems with Standard Formula if Tenants Have Insurance
Anchor tenants and tenants such as free-standing, fast-food restaurants usually have their own insurance policies, notes Goodman. These policies cover all the properties at which the tenant operates. It is more cost-effective for those tenants to include their portion of the center under their own coverage, rather than get coverage under your policy, he explains.
But look at what happens to the prior example if the anchor tenant provides its own insurance: The remaining four tenants' contribution of $25,000 will cover only half of your insurance costs. You will have to make up the difference until you can get a new insurance policy. Even so, a new policy will not make up for the shortfall in the other tenants' contribution.
Example: Suppose you drop the anchor tenant from coverage and your insurance now costs $30,000. However, the tenants' leases still say their shares are based on gross leasable area. The nonanchor tenants now pay:
Step #1: Calculate the drugstore's share: $30,000 insurance cost x (20,000 sq. ft. ÷ 100,000 sq. ft) = $6,000.
Step #2: Calculate the smaller stores' share: $30,000 insurance cost x (10,000 sq. ft. ÷ 100,000 sq. ft) x 3 (stores) = $9,000.
Step #3: Add the results of steps #1 and #2 together: You will collect only $15,000 ($6,000 + $9,000)—enough to pay only half the insurance bill.
Split Your Insurance Premium
There is a way to protect your wallet if you have at least one tenant with its own insurance, says Muhlebach. Split your insurance premium into two parts. Muhlebach makes sure that all new nonanchor tenants at his centers are required to pay his centers' insurance premiums in two parts. Use our Model Lease Clause as an example of how to set up the split premium in your leases.
Like our Model Lease Clause, your clause should first indicate that you will maintain certain types of insurance throughout the lease term, and that the tenant agrees to reimburse you for its pro rata share of the costs of your insurance relating to the center or its space as part of CAM costs, says Goodman [Clause, opening]. Next, discuss splitting the premium into two parts as follows:
First part. The first part of the premium should cover all of your insurance costs relating to the center, except those relating to common areas, says Muhlebach. Only the nonanchor tenants will pay this part. You will calculate their share by changing one number in the standard formula above—that is, instead of the “gross leasable area” component, you will use a “your insured area” component, which is the square footage covered by your insurance policy [Clause, par. a]. The formula for nonanchor tenants' contribution would look like this:
Your insurance cost x (tenant's area ÷ your insured area)
Example: Suppose you have a 100,000 square-foot shopping center, and the anchor tenant has its own insurance, so it drops out of the insurance pool. You pay $50,000 in insurance—$30,000 is allocated to the center's costs, excluding the common areas. Only the four nonanchor tenants, with 50,000 square feet of total space, are responsible for this part of the premium:
Step #1: Calculate the drugstore's share: $30,000 insurance cost x (20,000 sq. ft. ÷ 50,000 sq. ft) = $12,000.
Step #2: Calculate the smaller stores' share: $30,000 insurance cost x (10,000 sq. ft. ÷ 50,000 sq. ft) x 3 (stores) = $18,000.
Step #3: Add the results of steps #1 and #2 together: You collect $30,000 ($12,000 + $18,000), which covers the entire first part of your premium.
As tenants enter or leave your insurance policy, this formula will automatically adjust each tenant's contribution, notes Muhlebach.
Second part. The second part of the premium should cover only the costs of insurance for the common areas, says Muhlebach. Both the anchor and nonanchor tenants will pay this part. You will calculate each of their shares by using the standard formula based on gross leasable area, he says [Clause, par. b].
Example: Allocate the remaining $20,000 of your $50,000 premium as follows:
Step #1: Calculate the drugstore's share: $20,000 insurance cost x (20,000 sq. ft. ÷ 100,000 sq. ft) = $4,000.
Step #2: Calculate the smaller stores' share: $20,000 insurance cost x (10,000 sq. ft. ÷ 100,000 sq. ft) x 3 (number of 10,000 square-foot stores) = $6,000.
Step #3: Add the results of steps #1 and #2 together: The four nonanchor tenants would contribute $10,000 ($4,000 + $6,000).
Step #4: Calculate the anchor tenant's share: $20,000 insurance cost x (50,000 sq. ft. ÷ 100,000 sq. ft) = $10,000.
Step #5: Add the results of steps #3 and #4 together: The five tenants would contribute a total of $20,000 ($10,000 + $10,000), which covers the entire second part of the premium.
Why does this part also apply to your anchor tenant? Even if an anchor tenant has its own insurance policy, it still must be responsible for paying costs relating to insurance for the common areas, says Muhlebach. After all, the anchor tenant will benefit from the common areas, but its insurance will not cover them, he explains.
For example, the anchor tenant should help pay for repair or maintenance work to the center's parking lots, outdoor light poles, sidewalks, landscaping, and lobbies. Requiring the anchor tenant to contribute to this part of the premium helps reduce the cost to the nonanchor tenants and fairly allocates to everyone the insurance for the common areas, Muhlebach notes.
Be aware that unless its lease says so, an anchor tenant may resist paying the second part of the premium, says Muhlebach. Therefore, include the following language in the anchor tenant's lease, where it defines CAM costs, says Muhlebach. This way, the anchor tenant can't argue that it isn't required to pay that amount.
Model Lease Language
(x) The cost of insurance for the Common Areas.
CLLI Sources
Gary A. Goodman, Esq.: Sonnenschein Nath & Rosenthal LLP, 1221 Ave. of the Americas, 24th Fl., New York, NY 10020; (212) 768-6916; ggoodman@sonnenschein.com.
Richard F. Muhlebach, CPM, SCSM: Senior Managing Director, Kennedy Wilson Properties, 275 118th Ave., Ste. 105, Bellevue, WA 98005; (425) 453-2500, rmuhlebach@Kennedy-Wilson.com.
Sidebar
Sign up for a Free Commercial Leasing & Property Management E-Alert!
Twice per month, you can get a free E-News Alert sent to your email inbox that will give you the fast-breaking news, best practice tips, and compliance updates you need to stay on top of your industry and comply with the laws. Go to the real estate section of www.vendomegrp.com, and sign up for your free E-Alert now!
PRACTICAL POINTER: Will your tenants object to the new formula because it makes your nonanchor tenants pay more than they would if you used the standard formula? Muhlebach says tenants rarely object to this method of calculating their insurance contribution in new leases. They go along with this new formula, he says, once they understand that the calculation realistically reflects their prorated share of an owner's total insurance costs.
PRACTICAL POINTER: Your insurer will most likely lump the cost of improvements to the common areas with the rest of your center's costs and send you one bill with an aggregate number. To figure out how to split the premium into two parts, ask your insurance agent, as Muhlebach does, what amount (or percentage) of the premium should be allocated to the cost of insurance for the common areas and what amount (or percentage) should be allocated to all of your other insurance costs.
Also, if the anchor tenant, which has its own insurance policy, is occupying a free-standing or end building at your center, speak with your insurance agent about removing that building from your insurance policy, Muhlebach adds. There is no need for you to insure the building if the anchor's policy already covers it. But first make sure that your insurer gets confirmation that the anchor's insurance policy will cover your center's lender as an additional insured or loss payee, says Goodman.