Maximizing Tenant Improvement Alowances

By Bill White

Many corporate office tenants who are contemplating a relocation or re-negotiation of their lease often tend to over- focus on rental rates. This is understandable as their brokers and their landlord are oftentimes encouraging them to do so. While rental rates are important, it is imperative that tenants do not ignore the proper negotiation of other items such as tenant improvement agreements.

Given the highly competitive environment in which landlords find themselves, many are attempting to entice tenants by offering additional concessions including increased tenant improvement allowances. While these concessions may look appealing, it is critical that tenants take a close look at the provisions that dictate how these funds are utilized.

Like many of life’s problems, issues encountered by tenants implementing leasehold improvements or alterations often stem from a lack of planning. Traditionally, tenants negotiate the terms of their lease through their broker-prepared proposals outlining rent, lease term, operat- ing expense provisions and tenant improvement allowance. Landlords respond to these proposals with either a specific allowance or a “turn-key” proposal. Another approach often used by landlords is a “turn-key not to exceed” proposal which is an allowance posing as a turn-key offer. Oftentimes the allowance offered by the landlord looks appealing. For example, a client of mine leasing 20,000 square feet was recently offered a $25.00 per square foot allowance, or $500,000. Surely this would be enough to create whatever the tenant could imagine, right? Perhaps not.

Before agreeing to such a sum, it is critical that tenants take the appropriate steps to determine if the landlord’s offer is sufficient to meet their specific needs. Before a tenant agrees to any offered allowance a clear understanding of some key issues must be obtained: 1) What are the tenant’s specific requirements, or what does the tenant want to achieve in the space? 2) Is the building’s floor  plate configuration conducive to the tenant’s desired layout?  3) What will be the condition of the premises when the space is tendered to the tenant for construction? 4) What costs (other than actual construction costs) will the tenant be responsible for out of its allowance? 5) What items (other than actual construction costs) can be paid for out of the tenant improvement allowance?

Advance Planning Critical

Prior to going out and looking at buildings, a wise advisor will assist his/her client in the engagement of an architect or space planner to assist them in identifying their specific needs. This process, often referred to as “programming” will identify how much space will be required to accomplish the tenant’s stated goals and objectives and will have an impact on the type of building the tenant may want to consider.

With this information in hand, an experienced advisor will be better equipped to make certain he/she only shows the tenant buildings that meet their specific requirements. Once a short-list of buildings is selected, this “program” can be translated into specific floor plans for each building to create “test-fits.” These test-fits often uncover inefficiencies in some buildings. It is not un- common for a tenant’s required square footage to vary by as much as 20% from building to building due to shape, corridor configuration, and bay depths.

The advanced steps of programming and test-fits allow the tenant not only to see how their space will lay out in a given building, but  it will also help identify cost disparities  due to differing efficiencies.

Know what you are getting

Another important consideration when contemplating leasehold improvements is the condition of the premises. Is the space in “shell” condition, or are there existing improvements left from the previous occupant that will need to be demolished prior to the commencement of construction? Tenants are often led to believe that spaces with pre-existing improvements will reduce the required tenant improvement allowance and thereby save them money. This is not always the case.

Unless a tenant is willing to live with another tenant’s space (which could lead to other opera- tional / logistical issues) most of a space’s existing improvements end up being demolished. This additional step could deplete as much as $5.00 per square foot of a tenant’s allowance before the first wall is constructed.

In the case of shell space, careful attention must be given to the core / shell definition. Like ice cream, core and shell definitions come in many flavors. Knowing specifically the condition of the shell will allow you to prepare for additional costs during construction. Answers to the following questions will have considerable impact on the amount of your tenant improvement allowance that goes toward the actual construction of your space: 1) Will the interior perimeter walls be finished by the landlord?  2) Who is responsible for the lobbies and restrooms?  3) Who is responsible for the primary HVAC loop?  4) Who is responsible for window treatments?

What you don’t know can cost you. (a lot!)

Prior to committing to a particular building or tenant improvement allowance, it is important to identify any hidden costs associated with the construction of the premises. This can be accom- plished through careful review of the work-letter contained in the landlord’s draft lease document. Some of the most common costs tenants fail to recognize in the budgeting phase are as fol- lows: Construction management / oversight fees;  Utility “tap-in” fees;  Elevator usage fees; Contractor parking fees;  Loading dock fees;  and HVAC / utility fees.  While many of these costs are considered “standard” by many landlords, this can add up to as much as 10% of a tenant’s total improvement allowance.

Once these and other issues are resolved, and detailed construction estimates are obtained, the tenant should be in position to better evaluate the offer set before them.

If you have any questions about your lease, or the current status of the office market, please contact Bill White directly at 949-721-8880 or via email at bill@whitespaceadvisors.com

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