Strategies to Address Office Tenant Improvement Allowances
If you are in the midst of negotiating a new office lease, or perhaps you are contemplating a relocation in the near future, you may have encountered a topic of negotiation, the Tenant Improvement Allowance. Typically, especially in professionally managed office buildings, the Landlord will have a certain amount of cash reserves set aside to address needs of new or existing tenants when it comes to retrofitting their space or building out new spaces. This improvement allowance can be used in a multitude of ways, but generally in a new lease or renewal, these monies are applied directed by the requests of the Tenant and approval of the Landlord. There are a few ways to address the Tenant Improvement Allowance, a very important component of your office lease.
The Two Major Types of Tenant Improvement Allowances:
Turn-Key Build Out
A turn-key build out structure is a way to address the tenant improvement allowances in that the Landlord covers the entire build out costs as part of the deal structure. This typically includes both hard (labor, materials, etc.) and soft (design, architectural fees, etc.) costs associated with a build out. To get to a turn-key build out, a construction plan will generally have to be mutually agreed upon ahead of time, as this allows the Landlord to estimate the prices closely so that they know going into the deal exactly what they will be paying for and to make sure that the deal still works on their end with the Landlord completely covering the construction costs. Typically this cost does not include furniture, fixtures, and equipment (FF&E) specific to the Tenant unless this is negotiated and notated. A turn-key build out can be advantageous for both sides. For the Tenant, it is an easy and hands off approach. Simply agree on a test-fit layout and then allow the Landlord to turn it into reality. For the Landlord, after agreeing to a plan with the Tenant, the ability to monitor costs and control the process can be of great benefit. For a Tenant, however, a turn-key can be a detriment if any changes to the agreed upon layout come into play. Once a Landlord and Tenant have agreed on a layout in a turn-key build out, changes will have to be approved and either negotiated or paid for directly by the Tenant.
Budgeted Dollar Amount Build Out
A Budgeted Dollar Amount Build Out is a more traditional approach to a tenant improvement allowance. Under this scenario, the dollar amount a Landlord will contribute towards the tenant improvements is stated. This number is usually a function provided by the rental rate and term of a lease. In many instances, a higher rate per square foot or longer lease term will provide more tenant improvement dollars per square foot. This approach offers more control to the tenant in that the Tenant can work with the Landlord to get very detailed with how the dollars are applied. Should contractors estimate the work to exceed the budgeted dollar amount, additional tenant improvement dollars can typically either be paid as a reimbursement to Landlord by Tenant, or amortized into a rental rate over the life of the lease term. Negotiating more money in budgeted dollar tenant improvement allowance can be an extreme benefit to a Tenant, as a Tenant can negotiate that unused funds be applied to rent, be used towards FF&E, or even be reimbursed with a check.
Questions to ask:
Who will be managing the job and performing the work?
In a Turn-key build out, the Landlord will manage and perform all of the work. Tenant’s typically do not have much say in which contractors or used or how the process is managed. Under a Budgeted Dollar build out, either the Landlord or the Tenant can manage the work in some cases, and the Tenant has more of a voice when it comes to which contractors will be used and which product types will be selected.
What is included BEFORE the tenant improvement allowance kicks in?
This question is asking what work the Landlord performs before the tenant improvement dollars are applied. Sometimes referred to as “shell-condition” or “base-building” conditions, some examples could be that the Landlord will install HVAC systems, demolish existing improvements, or install restrooms before the tenant improvement dollars are applied. This varies with different Landlords.
Whether your company leases space with a turn-key or budgeted dollar approach to tenant improvements, the main thing is to make sure that your space captures the culture of your company, is a tool for recruitment, builds an efficient working environment, and promotes productivity while being cost-effective.
James Lomax is the Director of Asset Management at Corporate Office Properties Trust in Huntsville, Alabama. He can be reached at 256.698.3101.
CCIM 4Q19/1Q20 CRE Insights Report