OfficeTenant.com

The single largest chunk of cash to the landlord in leasing office buildings is the financial contribution it must make in order to finish the space to the specifications of the tenant. A fairly simple principal of exchange of consideration: The tenant agrees to pay rent for years in exchange for the space having been built in such a manner that the tenant can appropriately occupy the space. The landlord almost always has determined what basic allowance of cash for the construction it will spend in exchange for the rent. Landlords develop this cash allowance in several ways and the two most common are 1) a financial proforma, established way back at the investment level and certain assumptions were made as to income, expenses, capitalization, etc. or 2) The numbers are made out of whole cloth (often based on what the market will bear or simply what the owner feels like. It is usually the bank or investors which see these proforma and the landlord attempts to keep within these limits or face answering tough questions from the bank or investors. Improving on these assumptions (e.g.: more rent and less cash out and less operating expenses) is the mission of every owner and good property management team.

How or why these proforma are developed (doors, lineal feet of drywall, etc.) are important to the LANDLORD (it had to determine what it was going to spend). The problem is that many Landlords rigidly apply these allowances and don't understand that it should simply be the total dollars. Who cares if the tenant is going to have gold leaf on the walls or six internal stair cases or more likely, have several more doors, more drywall, more outlets, etc. In some cases, the landlord will attempt to do an item-by-item comparison determining how much drywall is designed compared to their limit, or how many doors compared with their limit. This is an absolute waste of all professional's time. Big deal if you design 100 lineal feet of drywall more that the landlord wants to provide or use less doors than they expected to provide. Do not allow the landlord to impact your analysis of its building by their providing such a computation to you. Simply acknowledge the work accomplished and request your architect to provide a total construction cost estimate which will be compared to what the owner hoped to spend. (Even if it will be your goal to get the landlord to spend more than it expected.)  Quick note: it is customary when touring properties for agents and landlords to get a feel for what kind of improvements you might require.  Either say it has not been fully determined, or indicate the need for a great deal more than you need.  If you have an open space plan requiring very little tenant improvements, keep that to your self as you need to negotiate for every dollar that the landlord would expect to have to pay.

Qualitative

Owners also spend way too much time concerning themselves with the quality standards of tenant finishes. When the original standards were selected, they ordinarily were simply chosen as the kind of finishes the basic building will provide like solid mahogany doors with brass hardware and 32 ounce cut pile carpet. Some landlords assume that this is static and cannot be beneath these standards of quality but neither can a tenant increase the quality of the items with out being responsible for the cost. They look at the quality of the finishes as a steel box out side of which the tenant can not go, at least not without penalty.

STANDARDS

There are certain buzz words that have been used with such proliferation in the real estate business that even those that use them have lost their meaning. More dangerous is when the same buzz word used by many different people is being used with different definitions. In tenant improvement lingo, the words "standard" and "standards" are tossed up at convenient times by landlords to indicate to you that you are about to blow through a red light at a train crossing. Having in their mind the quantities and quality of the finishes we reviewed above, you should be getting a sense that landlords like nice neat deals that don't wander to far from their concept of ideal. Each building has its predetermined ideal which is different from every other building. In many years, I have not seen two building’s standard finish schedules that were alike. Upon hearing the word standard (which usually means your bumping up against a potential conversation for the landlord to defend it), courteously acknowledge the conversation, but ignore its value. Landlords negotiate everything and tenant improvement is no exception. In fact, for all the proforma the landlord has developed surrounding the construction costs, and despite their quoted "standard" construction allowance, this is a category that is usually always negotiated.

Remember, your goal is management of this process. Don't get muddled in techno-conversations on tenant finish allowance standards. You already have the Criteria/Needs Assessment complete, so you know what is needed. You have the Building Technical Breakdown complete and the Tenant Improvement Allowance breakdown form  showing both what they are offering and what is already in the space (which might be of value or might need to be demolished) so you, your team and architect can accurately determine the financial viability or problems with a space.

Developing the hard construction costs is a process that will be developed in two stages: The Preliminary cost estimate and the Final construction estimate which is discussed in later. This sounds like kindergarten, but there is a distinct difference. Remember, that to maintain control over the negotiations, you must have control over the information.

The preliminary cost estimate is determined within the walls of your team with the considerable input from your architect. As part of his or her job they must be able to have access to reasonably accurate construction cost prices preferably based on "unit pricing", as opposed to having to deliver full-blown construction drawings to a general contractor who takes two weeks to review them and discuss it with eleven sub-contractors. You can not afford that sort of delay and nor can you afford the multiples of details, conversations and meetings required to deal with the actual sub-contractors who usually won't give an accurate bid unless the specifications are pinned down. This would be multiplied in difficulty if you have to go through this exercise at several buildings. You are not at that stage yet. You simply need to get a good, firm estimate of the expected construction cost which your team will compare with the building tenant improvement allowance.

Now you have enough information to accurately negotiate with the landlord as to the requirements they must meet in order to accommodate your Criteria. Remember, there is always room for negotiation. As part of your negotiations, don't request, indicate that these are the minimum requirements to meet your criteria. The cost may be beneath, above or at what the landlord wants to spend, which creates a framework for the landlord to respond to other issues, like rent, knowing what the out of pocket construction will be.

When negotiating the tenant improvement allowance, it is important to know what the landlord is using as a basis for construction. What portions of the common areas are to be built and expected to be paid for from your allowance?  There are as many different ways of determining this as there are moods of the landlord, so your team must have this pinned down, which can easily be highlighted in the Tenant Improvement breakdown form. One easy way to get more cash for construction is to have the highest possible allowance number you can negotiate multiplied by the "rentable" area that will appear on your lease. You are not building the rentable, you're building the usable. If the load factor in the building is 14.5% you are getting 14.5% more cash to build your actual space. Obviously, if you’re looking at buildings that do not charge on a rentable basis then this opportunity does not exist. However, you may be looking at several different buildings which have rentable and usable. Your architect will be able to calculate the available cash to build the area you will occupy.

During your negotiations on tenant improvement, the final cost may be above what the owner is willing to spend. Of course you can always pay the difference, which is exactly what the landlord wants you to do. What is better for you is for the landlord to pay for it and amortize the additional cost over the term of the lease which increases your occupancy cost. That is okay as long as you know how to handle it and compare against the other buildings you may be considering. Amortization is a great tool which means simply that you are borrowing the money from the landlord and paying it back with interest in equal monthly installments. Ordinarily, it is billed right into the monthly rent which means you only write one check. From a balance sheet point of view, this is terrific because it is paid as rent and ordinarily not considered as a long term loan. Had you gone to the bank and borrowed the same amount, it would show up on you balance sheet as a loan or long term liability. You can always go to the bank to borrow the money as an option, but by doing it through the landlord, it is likely you need not put up collateral or cut into your line of credit. Banks want collateral (unless you have a great relationship) and borrowing from the bank may create a lien on some property, personal or real estate or blanket lien. 

The ideal obviously is to hold negotiations on this point until other elements have been agreed to, make it a condition of the lease, and have the landlord pay all the improvements as a concession.

When it costs less to build the space than the landlord is prepared to pay you have options also. First, keep this little secret from the landlord for now until you develop a plan. Remember the landlords want to spend as little money as possible and collect as much rent. Provided you are successful in attaining the rent you desire from the landlord (with the landlord assuming he is paying the allowance - remember the exchange of consideration) you should be able to 1) design, spend more of the landlord's money on luxuries like a full blown kitchen, terrific wall covering, glass partitions, marble top counters, whatever, 2) seek a proportionate reduction in the rent, 3) take the difference in cash, or 4) take the difference in rent abatement. The easiest and least noticeable is to design more. The landlord probably couldn't care less as long as his maximum isn't passed. In this case it may also be possible to "build" some of those items which would ordinarily be considered tenant's personal property like modular partitioning, computer cabling, telephone system or installation. These items can easily be provided through the general contractor or have your vendor become a sub-contractor to the general contractor. The downside is that for those items that are obviously used by the tenant and removable like desks, lamps, etc. the landlord takes a dim view of funding your property. If the underage is substantial, say $6.00 per sq. ft. on a 10,000 sq. ft., $60,000 would go along way, and it may be better to reduce the rent. But $3.00 per sq. ft or $30,000 is only equivalent to two months at a $20.00 per sq. ft. rent. Landlords usually have a problem in convincing themselves or their bank that they should turn over a check for the tenant's discretionary purposes, however aggressive developers that are rushing to pre-lease a  building in order to make a financing deadline will eagerly pitch away cash to seal the deal.