Which Capital Expenditures Are Recoverable in CAM?

The General Rule: Capital Is Not Recoverable

The cornerstone of CAM expense classification is the capital/operating distinction. Operating expenses maintain the property in its current condition and are recoverable. Capital expenditures improve, replace, or extend the life of a building component and are generally not recoverable — because the tenant would be paying to improve the landlord's asset.

Standard NNN lease language excludes capital expenditures from recoverable CAM either explicitly ("excluding capital improvements as defined under GAAP") or by including only "operating and maintenance" expenses in the defined recovery pool. Either way, a landlord who books a $250,000 HVAC replacement as a GL expense and includes it in CAM is creating significant audit exposure.

The Amortization Exception

Most modern NNN leases include an amortization carve-out that permits recovery of two categories of capital improvements:

• Law-required capital: Capital improvements required by applicable law, ordinance, or regulation after the commencement date of the lease.
• Expense-reduction capital: Capital improvements that reduce operating expenses that would otherwise be recoverable from tenants.

For both categories, the typical requirement is that the capital cost be amortized over the useful life of the improvement, and only the annual amortization amount (cost ÷ useful life years) may be included in CAM charges.

IRS Useful Life as a Guide

When the lease does not specify a useful life, landlords typically reference IRS depreciation schedules as a reasonable proxy. Tenants and their auditors use the same reference point, so using IRS-based lives reduces dispute risk.

Law-Required Capital: Recoverable Without Amortization Requirement

Capital improvements mandated by law — ADA compliance work, seismic retrofitting required by local ordinance, fire code upgrades, and environmental remediation required by law — are recoverable in most leases without requiring full amortization over useful life. The rationale: neither party anticipated the requirement, and it would be inequitable to require the landlord to absorb the entire cost.

Even for law-required capital, some leases impose an amortization requirement. Review the specific lease language. The critical question is whether the lease says "amortized over useful life" for law-required items or whether law-required capital is separately addressed.

What Tenants Contest in CapEx Recovery

Even when the lease permits amortized CapEx recovery, tenants routinely dispute specific elements:

• Useful life used (too short): A shorter useful life produces a higher annual amortization charge. Tenants will compare the life used against IRS schedules and industry standards. Using 10 years for a roof replacement that has a 25-year IRS life is difficult to defend.
• Whether the improvement was truly required vs. voluntary: An HVAC replacement because the old system was inefficient is not the same as one required by ASHRAE code changes. The landlord must document that code, law, or demonstrated expense-reduction need drove the improvement.
• Including interest or financing costs: Unless the lease explicitly allows it, adding a financing cost component to the amortized amount is unauthorized. Tenants will strip it out and calculate damages on the excess charged.
• Expense-reduction capital where savings aren't demonstrated: If the landlord claims a capital project reduces operating expenses, tenants will ask for documentation of the actual savings achieved and how they were passed back.

What Can Go Wrong

Frequently Asked Questions

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