Commercial Office Space Construction Basics

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 a tired space, or an extensive, full build-out from a “shell condition.”

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 $2.00/Rentable Square Feet (RSF) for new paint only to $50.00/RSF, or more, for an extensive, high-quality build-out where there are no existing walls, ceiling, etc.

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.

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
• Tenant’s credit strength
• Vacancy rate in the building (which impacts a Landlord’s level of motivation)
• Type of building owner (institutional vs. private), and
• 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).

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.

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.

In the next issue, we will look in more detail at issues related to effectively utilizing a Tenant Improvement Allowance.

If you’d like to learn more about tenant improvement allowances, please contact us.