Although it is common practice for companies to allow room for negotiation in order to help land new customers in just about any industry, people tend to think it does not apply to renting warehouse, retail or office spaces. There are many examples of this. Cell phone companies are known to offer to pay cancelations fees that a new customer would have to pay to get them to switch their service provider. Department stores will have sales and discounts in order to entice customers to shop there. Car dealerships are extremely flexible when it comes to making a deal that will encourage the customer to buy their cars. No matter where you look, you will be able to find examples where the seller makes sacrifices that will benefit the customer in order to generate sales.
Landlords are known to do this as well when it comes to office space rentals. Most office spaces will have to be altered (e.g. new carpet, paint, remove/build walls, etc.) in order to fit the needs of the tenant. This is especially true in areas where there is low demand for space or there is more rental space than there are people looking to rent.
In order for a landlord to entice a renter to rent their space over someone else’s, they may offer a tenant improvement allowance. A tenant improvement allowance (TI) is a specified amount of money that the landlord will give to the tenant in order to use for upgrading and renovate the space. The amount will usually be based on the square footage of the space.
The TI will typically be negotiated during the discussion of the lease terms. During these negotiations, the tenant should aim to get as much money per square foot to give them more options regarding what they can do to improve the space to fit their needs. They should try to ensure that they will have enough allowance to cover their minimum needs and ensure that they will be able to control the building and spending of the allowance so they can have exactly what they want built out for them.
How much TI is enough?
Before the negotiations begin, the tenant should have a clear idea of their ideal layout and the amount that they will need. Without this, the tenant could mistakenly agree to a TI that is much lower than what they would actually need. Consulting with a space planner or architect is always a good idea.
When you are preparing for TI negotiations, take into account all possible expenses including the build costs, utility expenses, and anything else that the TI could potentially cover. The amount that the tenant should try to get will depend on their specific needs. The tenant should aim to have all of their expenses covered with the allowance, but it is common to settle on an amount less than that and split the costs between the landlord and tenant. The amount the landlord is willing to give is contingent on market conditions, your financial stability, and lease terms, and whether or not the build out improves the space.
Who manages the work?
You should also discuss which party will control the hiring process to have the work done. In most cases, the landlord will remain in charge of this process because they own the property. Depending on the size of the space the tenant may wish to be involved in the process in order to maintain control over the final build. In either case, this is something that should be worked out during negotiations. Typically if your leasing more than 10,000 to 15,000 sf you should try to take control of the process, otherwise just let the landlord handle it if they are capable of doing so.
Turnkey build-out (Landlord Has Control)
A turnkey build-out is a term used when the landlord opts to have full and total control over the entire build and cost. In this case, the tenant will remain completely hands off and simply begin the lease when the build is complete. This will save a lot of time and hassle for the tenant and allow the landlord to build the property as they want.
The downside of this for the tenant is that they may not get exactly what they want. If the landlord is acting in their best interest, they may make decisions or cut corners to save costs that could go against the needs of the tenant. Landlords may not shop for the best price or get multiple competitive bids. Additionally if the landlord said they would pay for up to $35 sf and the actual price was $25 sf……you just lost $10 sf in improvements. Again if your leasing more than 10,000 sf it's typically to your advantage to refuse turnkey and take a TI allowance.
TI Allowance (Tenant Has Control)
If the tenant would like to oversee the construction process themselves, they can opt for full tenant control. This will take the power out of the landlord’s hands and allow the tenant to ensure that everything is built to fit their needs and ensure that every dollar is well spent. This will give the tenant a lot more work to do during this phase and is typically reserved for tenants that plan to rent the space for an extended period of time or for very large build plans. This route will also give the tenant a better understanding on the costs of the construction and allow them to make better financial decisions throughout the process.
TI Allowance (Landlord Has Control)
If the landlord insists on keeping control over the construction process, there is still room for the tenant to retain some of the power to make certain decisions.
There are 4 things that the tenant should focus on during negotiations:
- Require the landlord to go through a process of competitive bidding. This involves receiving sealed bids by multiple companies which are only opened in the tenant’s presence. This will allow the tenant to have a say in choosing the best prices for the job.
- Tenants should inquire if there are any overhead or administrative fees that they will be charged to oversee the construction process. If there are, the fees should be checked for any reductions and to see if they can be avoided altogether.
- Tenants should request a detailed overview of the process and materials used so they have a clear idea of what the total costs will be.
- You want the landlord to be accountable for any construction delays that are the Landlord's fault…. the same that they would expect of you. Depending on your situation construction delays can cause office set up inconveniences, holdover costs, etc.
What does TI cover?
TI usually covers all hard construction costs. Soft costs, such as attorney and architect fees, permit costs and legal fees are not always covered by TI, however these can be negotiated by the tenant during the initial talks. TI also does not typically cover data / phone cabling. That is almost always a Tenant expense however that can be negotiated also. Your goal is to be able to spend 100% of the TI allowance. If there is money left over negotiate to use that towards free rent or other future improvements.
There is always room to negotiate
A TI is a huge benefit to a tenant. The reason it is being offered in most cases is because the landlord is eager to rent out their space. Just because it is being offered does not mean the tenant should stop there. There is always room to negotiate to further benefit the tenant and they should do everything they can in order to reach an agreement that will benefit them the most.