Understanding pro-rata share is crucial when investing in commercial real estate, as many leases use this term. Pro-rata refers to the method of distributing expenses among tenants in a specific building. The pro-rata share shows how much each tenant pays for shared costs. These costs include maintenance fees, utilities, and property taxes. Each tenant’s share depends on the size of their leased space compared to the total area available for lease.
In this blog post, we will guide you on how to calculate pro-rata shares in commercial real estate. We will also include examples that show why this is important in lease agreements.
What is Pro-Rata Share?
The term pro-rata is frequently mentioned in reference to triple net leases (NNN), net net leases (NN), or net leases. Pro-rata calculations are integral for distributing expenses among tenants in commercial properties. The net charges include Real Estate Taxes, Insurance, and Common Area Maintenance (CAM) expenses – based on whether the lease is N, NN, or NNN. This allocates costs proportionally based on an individual unit’s specific square footage occupancy, ensuring fair financial contributions towards shared expenses.
In the NNN lease which includes CAM, pro-rata calculates each tenant’s share of the building’s expenses, such as lobbies, hallways, parking lots, landscaping, and other communal facilities. This calculation shows how much of the expenses a tenant must pay. This should be clearly stated in the lease agreement.
Property managers can use pro-rata to help calculate the tenant’s share, maintain transparency with tenants, and minimize disputes and equity regarding shared financial responsibilities. This helps manage property expenses well. It also keeps common areas in good shape. This allows tenants and landlords to use resources more flexibly.
Types of Expenses Included in Pro-rata Calculations
Pro-rata share calculations include various expenses for operating and maintaining a commercial property. These expenses may consist of:
Common Area Maintenance (CAM)
CAM fees are essential contributions that help fund the maintenance and operation of shared common areas within the property. What is included in CAM varies by region and the type of property but could include such expenses as:
- Landscaping
- Cleaning
- Security
- Parking lot maintenance
- Elevator maintenance
- Utilities like water, electricity, and gas that support these common areas
- Property maintenance
- Snow removal
- Permits
The specific expenses included in pro-rata calculations can vary by lease agreement. Some expenses may be included or excluded during lease negotiations for a specific tenant. Tenants and landlords should review the lease carefully to understand which expenses are counted in the pro-rata share for each lease.
Property Taxes
When calculating how much each tenant should pay, part of the costs can include property taxes for the entire commercial building. This is usually divided based on how much space each tenant occupies. For example, a tenant occupying 20% of the total space would be responsible for 20% of the property taxes.
Property Insurance
Property insurance, which encompasses types such as fire and liability coverage, can be included in pro-rata calculations to ensure equitable distribution of expenses among tenants. All tenants collectively share the responsibility of maintaining essential insurance protections for the property.
Calculating Pro-Rata Share in Commercial Real Estate
Pro-rata share is commonly used in commercial real estate to determine the fair allocation of expenses among tenants in a shared space. It may involve nuances due to potential differences in square footage calculations between leases and the overall building measurements.
Calculate the total expense
Gather detailed information on all expenses associated with the property, including regular maintenance costs, property taxes, insurance premiums, and utility bills. Make sure to gather all the financial information. Then, calculate the total expenses for the property.
Use calculation methods
The most common approach is to use square footage, where the total property area is divided among tenants based on the size of their leased space.
First, determine the rentable square feet of space the tenant is leasing. Second, check the total rentable square feet of the building, which is the amount of space used to calculate the pro-rata share. Third, divide the rentable square feet by the total rentable square feet using the measure defined in the lease. This gives you the percentage of the total space occupied by the tenant.
Last, multiply the percentage of total space occupied by the tenant by 100. That will give you the tenant’s pro-rata share calculation.
Review and update regularly
It is important to review and update the pro-rata share regularly. This may change if a tenant increases or decreases their space. It can also change if an amendment states that a tenant is now responsible for a specific expense at a higher rate.
For example:
- If there are fixes or upgrades, the costs associated with maintaining and improving the property are shared proportionally.
- If the lease agreement specifies that expenses are divided based on occupied square footage only, you must exclude the vacant spaces from the calculation.
Other Pro-Rata Share Considerations
In commercial real estate, it’s important to understand that the area for pro-rata share calculations can be restricted. This area may only include part of a building or the total square footage of several buildings.
This means tenants in different spaces, such as retail or office units, may have varying defined areas, which can affect their pro-rata share calculations differently. Therefore, a thorough review of the lease is essential for understanding how the defined area is determined.
Maintaining precision when calculating the pro-rata share in commercial real estate is essential. Accurately estimating the pro-rata share ensures that each tenant pays a fair and equitable portion of operational costs.
Overpayments can strain a tenant’s cash flow, and the reconciliation and reimbursement process can be a hassle. On the other hand, underpayments may create a huge financial burden for tenants if landlords discover discrepancies and demand compensation for the shortfall. This can impact not just one expense but potentially many. To prevent such issues, it is smart to check the lease and thoroughly calculate the pro-rata share upfront.
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