10 Essential Tenant Improvement Issues-Part 1

10 Essential Tenant Improvement Issues-Part 1

By Mark D. Rauch

Most commercial office Lease transactions involve some sort of interior Tenant Improvement ("TI") Construction. This can be as minor as adding new paint and carpet to spruce up tired space, or an extensive, full build-out from a "shell condition."

1. Funds to Pay for Build-out of Space

Often a Landlord provides a Tenant Improvement Allowance to fund the reconfiguration of office space to better suit a Tenant's specific needs. This can include adding or removing walls, moving doors, adding lighting or by adding or refurbishing a break area or work room. A Tenant Improvement Allowance can range from $10.00/Rentable Square Feet (RSF) for new paint only to $60.00/RSF, or more, for an extensive, high-quality build-out.

2. What Tenant Improvement Funds Can be Used For
Landlords typically allow Tenants to utilize a Tenant Improvement Allowance to pay for interior elements associated with improving a Landlord's building that will have residual value. Therefore, a Tenant Improvement Allowance generally cannot be used to pay for Tenant furnishings or a Tenant's phone/data cabling installation although many times your Tenant Rep will be able to negotiate some of these items into the Tenant Improvement allowance.

3. How Tenant Improvement Funds are Determined
The amount of Tenant Improvement Allowance offered varies, and is often quoted as "negotiable" by the Landlord or its listing brokers. The key factors impacting a Landlord's determination of the Tenant Improvement Allowance include the length of the Lease term, the Tenant's credit strength, the Vacancy rate in the building (which impacts a Landlord's level of motivation) and the Type of building owner (institutional vs. private). Because the Tenant Improvement Allowance is a concession offered to Tenants, Landlords will offer more generous Tenant Improvement Allowances during soft markets (when vacancy rates are high) and less Tenant Improvement Allowance as the office markets strengthen (i.e. vacancy rates drop).

4. The Build-out Process

If a Tenant Improvement Allowance is offered to the Tenant, the Tenant may hire the architect, engineers and general contractor and assumes the management responsibility and financial and schedule risk for completing the project. Alternatively, the Landlord may hire the design and construction team and manage the project. Under both arrangements, the key issue for the Tenant is developing a detailed construction plan and securing accurate advance construction cost estimates in order to feel confident that the Tenant Improvement Allowance will fully cover the construction costs or, if not, know in advance the additional amounts it must pay to complete the project.

5. Turnkey build-out
In some cases, a Landlord will offer a Tenant a "Turnkey" build-out of the Tenant's desired layout. With this arrangement, the Landlord and Tenant mutually agree upon a construction plan and the Landlord then hires, supervises and pays the architect, engineer(s) and general contractor as necessary to deliver the space to the Tenant as had been mutually agreed. Under this arrangement the Landlord assumes the management and schedule risk and the Tenant is essentially handed the keys to its newly completed space. The key for both the Landlord and Tenant is having a plan that clearly identifies what will be delivered to the Tenant.

6. Determining the Tenant Improvement Allowance
The amount of Tenant Improvement Allowance that a Landlord is willing to offer a Tenant depends upon several factors including the length of the Lease term, the Tenant's credit strength, the vacancy rate in the building (which impacts a Landlord's level of motivation) and the type of building owner (institutional vs. private). Because the Tenant Improvement Allowance is a concession offered to Tenants, Landlords will offer a more generous Tenant Improvement Allowance in soft markets and less Tenant Improvement Allowance as the office markets strengthen.

7. Who Oversees Construction?
In many cases where the Landlord offers a Tenant Improvement Allowance, the Landlord will hire the architect, engineers and general contractor and will provide the construction management for the project, typically charging a fee of 3% - 5% of the construction costs. This method can be advantageous to a Tenant who does not have the time or expertise to effectively manage a Tenant Improvement Construction project. In addition, schedule delays (unless caused by the Tenant) become the Landlord's responsibility, and the Lease Commencement date will typically be the date that the Landlord has "substantially completed" the Tenant Improvement Construction and the Premises are available for occupancy.

8. When the Tenant Controls the Process

In other cases, a Tenant may hire the architect, engineers and general contractor and assume the management responsibility for completing the project. The Tenant gains more control but will also assume significantly more responsibility and risk for completing the required Tenant Improvements. Delays in the schedule may hurt the Tenant if the Lease is structured such that the Lease commences, for example, 90 days after Lease signature. If there are construction delays, the Tenant may be responsible to pay rent even though the Premises are not ready for occupancy. There is also a hybrid scenario wherby the Tenant will hire the architect and the Landlord will use his/her contractor to build the space out.

9.Know the Costs Upfront
Under either arrangement, the key issue for the Tenant is developing a detailed construction plan and securing accurate advance construction costs estimates so that the Tenant is confident that its Tenant Improvement Allowance will fully cover the construction costs or, if not, the Tenant knows in advance the additional amounts it must pay to complete the project.

10. Benefits of Using a Project Manager
Tenant Improvement design and construction is time consuming and requires attention to detail. Numerous decisions are required ranging from office and conference room sizes and locations, to paint, carpet and counter surface selections, to details about electrical outlets and lighting. Changes made after construction has started can be expensive. Many Tenants engage outside Project Managers to help them successfully navigate the Tenant Improvement Construction. Experienced Project Managers easily earn their fees by savings Tenants thousands of dollars in the design and implementation stages of a project.