Real Estate Marketing & Beyond
When leasing commercial real estate, tenants need to budget for the buildout. A buildout includes adding walls, doors, outlets, cabinets, and anything else that constructed in the rental space. In office leases, the lease usually requires that the landlord pay the cost of the tenant’s buildout.
No matter what the lease says, the tenant always pays for the buildout. Where the tenant does not pay cash up front, the cost will be included in the rent throughout the lease term. Savvy tenants will negotiate language in their leases to their advantage.
Leases may describe the landlord’s buildout obligation either as fixed tenant improvement allowance or as turnkey buildout completion. With an agreed-upon tenant improvement or buildout allowance, the tenant must pay any costs above the allowance. But the landlord assumes the risk of cost overruns with the turnkey completion.
Although it may sound like the turnkey completion is better for tenants, that isn’t always the case. Turnkey completions provide tenants with cost certainty. But, they may cost tenants more or produce a lower quality buildout than expected.
Remember, the rent includes the cost of the buildout. A landlord agreeing to a turnkey buildout will not risk losing money on it. So, landlords will add a cushion into their cost estimates for their buildout when quoting the rent amount. If the landlord completes the work for less, the landlord enjoys the savings. But the tenant still has to pay for the higher estimated cost through its rent.
Before agreeing to a turnkey buildout in a lease, tenants should review every detail in the plans. Landlords and tenants should agree to every detail in advance, even locations of electrical, telephone, and ethernet outlets, specific carpet style and cover, wall coverings, and millwork selections. Tenants that don't establish these details in advance and include them in the lease may have an unpleasant surprise when the work is complete.
Tenant improvement or buildout allowances also have benefits and drawbacks. Some landlords set unreasonably low allowances which enables them to give low rent quotes. When that happens, tenants may find the buildout costs a lot more than expected. As with turnkey buildouts, the savvy tenant will complete its plans and evaluate finishing costs in advance to assure that the allowance amount is adequate.
Tenant improvement allows usually are quoted based upon the square footage of the rental rate. For tenants who have “typical” needs, that may be fine. However, tenants who require more construction than average may find the allowance isn’t sufficient.
Tenants who don’t want an up-front cash outlay for excess building amounts may want to negotiate the right to amortize those amounts over the term of their leases to save on the up-front cash outlay. If a lease has a tenant buildout allowance, the tenant should insist that any cost savings operate as a rent credit.
Often, landlords will include imputed interest when adding buildout costs to leases. In those cases, tenants should insist that that the “interest” which would have been paid on any cost savings also be credited against rent. Tenants who ask to amortize excess costs over the terms of their leases should, likewise, expect to pay an imputed interest amount.
All tenants should be able to save on rent costs by evaluating their buildout needs. For example, although a tenant may need high-quality carpet in high-traffic reception areas and hallways, maybe less durable carpet is adequate in offices.
Many tenants find side lights (the windows next to doors) desirable, but they also add to costs. Minimizing or eliminating sidelights is another way to save on costs. Doors also cost money. If there is a room, such as a break room, where the door never is likely to be closed, tenants can consider not putting a door on that room to begin with.
Tenants with turnkey agreements should be sure that the rental rate is adjusted in the lease to account for any cost savings.
Completion date may be important to some tenants, such as those whose lease is ending at their current location. If completion date is important, it should be in the lease. There also should be significant consequences in the lease for failure to meet the deadline to encourage timely completion.
Landlords and tenants also should agree upon what “completion” means. For example, some localities require a certificate of occupancy (CO) to assure that building code requirements have been met before a tenant can occupy the space. Landlords frequently use issuance of the CO to define “completion.” A better approach is to define completion as completion of all (or at least all important) items on the plans.
Building inspectors aren’t concerned about whether the carpet is correct or millwork or cabinets are installed, or whether other items not covered by building codes are complete. Therefore, it is possible a CO could be issued before the tenant considers the buildout to be near to completion.
Landlords and Tenants also should agree in the lease upon expected construction quality. Leases frequently will require “builder standard” quality. Before agreeing to this, tenants should determine what that term means. Even if other tenants’ buildouts are of acceptable quality, the landlords could consider them to be better than building standard.
Landlords may require that all tenants accept either a turnkey buildout or a tenant allowance. Whichever approach is used, careful planning of buildout details and negotiation of lease terms in advance can save money and assure the tenant’s
