When tenants negotiate leases, they frequently focus on the basic numbers -- the amount of the per square foot rent, the size of the space and the size of the tenant improvement allowance. However, seemingly small details can have a significant impact on the overall economics of the transaction -- frequently outstripping what a dollar or two of rent would mean. This is especially true when it comes to your TI allowance.
Done vs. Dollars
At first glance, a lease that includes turnkey TIs might seem like a good deal. A turnkey agreement means that you theoretically don't have to take any money out of pocket to get your space configured for you. However, behind the scenes, the landlord is offering this because he expects to save money.
When you get offered a flat tenant improvement amount, the landlord is assuming that he can build the space for less than you think. For instance, if you ask for $50 per foot and your landlord comes back with a turnkey offer, he's probably expecting to build your space out for between $40 and $45 and to pocket the difference. Unless you can get an ironclad work order included in your lease that clearly specifies what will be built and to what standards of quality, taking a set dollar tenant improvement allowance will usually get you better space.
Whose Job Is It?
Another way that your landlord can reduce the cost of providing a tenant improvement allowance is to gain additional control over the construction process. If he can get himself or one of his companies named as the construction manager, he will be able to keep any materials discounts as well as retain the contracting fees and any labor markups. In a worst case scenario, he could end up being more expensive than bringing in an outside or managing your own project, leaving you in a situation where your tenant improvement allowance doesn't go as far as you expect.
Measuring Your Space
The measurement of your space doesn't only impact your tenant improvement allowance -- it also impacts your rent. If your space is measured improperly and you end up being assigned too much common area, you will end up paying more rent. While a TI allowance that is based on rentable area will give you more TI dollars, you still will usually do better if your space is measured properly in the first place.
The best way to play the measurement game is to have your space measured accurately. At the same time, write your lease to request that your allowance be granted on the basis of the rentable square footage that you pay for instead of the smaller usable square footage that you occupy. This gives you extra TI dollars to use on your project.
The Cost of TIs
Finally, when you negotiate your tenant improvement allowance, remember the old economist's rule that "there ain't no such thing as a free lunch." Your landlord is looking at the total cost of your lease and an extra dollar that he gives you in TI allowances has to be balanced out somewhere, such as in a higher rent or a more aggressive rent increase schedule. With this in mind, settling for fewer TIs and a lower rent could work out to be the best deal for you.
How to Negotiate The Best Terms
It's rare to find an office space that you can move directly into after the lease is signed. Nearly all offices will require some tenant improvements to complete or customize the space in order to make it ideal for tenants' needs. The tenant improvement allowance helps to cover these costs, making it important that you negotiate to get the best possible deal. Following these tips will put you on the right track:
Evaluate the Space
Before you even begin to talk tenant improvement allowances with the landlord, take the time to evaluate the space. Is it just a shell that needs completely built out or a finished office? A bare shell will require money for ceiling grids, heating and cooling systems and other necessities, leaving less room in the budget.
A minimally built out office will often give you the most bang for your buck as you can use what is already present and simply make the customizations that you need. For an office that is fully built out and customized, you'll want to reuse as much as possible in order to reduce demolition and rebuilding costs.
Prioritize Your Needs
Once you have evaluated the space, make a list of all of the improvements that you'd like to see. Then rank them from the most essential to your business operations to those that are simply wants and not needs.
Get Estimates on Your Own
Before you head to the negotiating table, do some research to get a rough idea of how much the various improvements that you will be requesting cost to complete. This will help you fairly evaluate your landlord’s tenant improvement allowance offers.
Think About the Effects on Other Costs
As you negotiate, keep in mind that tenant improvement allowances are not free. Landlords will often increase rent expenses to recoup the money spent on tenant improvements.
Consult a Tax Expert
For many companies, rent is completely tax deductible, while tenant improvements often are not. Consult your accountant to find out the specifics of your tax situation. You may find that it would be better for the landlord to greatly increase your rent and give you a large tenant improvement allowance.
Retain the Right to Stay Involved in the Process
Whether you need only a few minor improvements or a complete build-out, you'll want to stay involved in the process. Having a say in which contractors are selected and being able to communicate with the construction project manager will give you more control, so that you can maximize your budget for tenant improvements.
Ask for Abatement If You Hit a Roadblock
If you reach an impasse with the landlord, consider shifting gears and asking for a rent abatement in lieu of a large tenant improvement allowance. Rent abatement is virtually free for landlords, so most will be more generous with providing a few months of free rent. You can then use the funds to pay for tenant improvement allowances out of your own pocket.
Negotiating your tenant improvement allowance allows you to have more flexibility and control over the construction process. This leads to greater transparency in costs, so you avoid a bigger bill from the landlord when the project completes. Regardless of how you choose to negotiate your tenant improvement, it is essential that you get exactly what you need from the new space while your expenses are minimal.
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