Hidden Cost Traps in Commercial Leases
The second largest line item on most businesses’ budgets, coming in just behind personnel costs, is occupancy costs.
There are four major economic issues a tenant should focus on before entering into a lease to best control overall expenses. These include:
Base rent and yearly increases
While the first three are often the main focus of negotiations, let’s first focus on what I like to call the proverbial “Bottomless Pit”, AKA Tenant Improvements.
Landlords may offer tenant improvement allowances included in rent costs, which can come in the form of a specific a dollar to be spent on improvements (TI allowance) or a Turn-Key buildout. Whichever type of allowance the landlord offers, it is critical before signing a lease that you know exactly what the costs will be to improve the space.
In either case, you would start with a basic generic space plan based on your specific needs such as number of offices, conference rooms, open spaces, kitchens, etc. The space would be built out using the materials the landlord typically uses on all suites (Building Standard materials).
In a “Turnkey” build-out, you tell the landlord all of what you need and assuming the costs fit within his budget and that you use his Building standard materials he will build the space to your specs. However, you would likely have to pay additionally for items that he considers above his standard materials. Examples might be drop lighting, upgraded carpet or wallpaper.
In a fixed TI Allowance, regardless of what materials you use, the landlord will contribute only the amount of money agreed to. ANY cost above that would be your responsibility. It can be paid up front or amortized into your rental rate over the term.
In one case, we were asked by an attorney to review a lease for one of his clients. The landlord offered a fixed allowance and presented the tenant with a plan the landlord prepared. But the way the landlord’s architect laid out the plan the tenant submitted, the architect designed a space that was 30% greater than the tenant needed and included items the tenant didn’t ask for. Using that plan the additional cost out of pocket for greater rent, based on the larger/unneeded space and the items that were considered over standard would have cost the tenant almost $650K over the term to lease the 12,500 RSF premises.
Alternatively, we had a client who leased a 22,000/RSF full floor. With careful planning, weekly construction meetings and a lot of “horse trading” on potential changes, had it not been for a last minute request to change one wall in the managing partner’s office which cost $3,500, there would have been zero out of pocket costs to the client on a $1.2M improvement budget.
It is as critical for all tenants large or small to understand potential improvement costs BEFORE signing the lease. Landlord’s love to say, “Oh, we can do that,” but remember, it’s at a cost.