Some property owners of commercial real estate may not understand the reasoning behind why a tenant who has been renting a retail or industrial space for some time, perhaps 5 or 10 years, would want to include a commercial real estate broker tenant representative as an advisor when it is time to renew the lease, change the lease to include an expansion, or agree upon some other transaction with the landlord.

If you think about it, how is a renewal any different than an initial lease transaction? Does the commercial lease not need the same expertise, market and lease knowledge, and experience that can only be assured by engaging a professional advisor? Craig Trbovich, Sales and Leasing Advisor at Commercial Properties, Inc. commented in a LinkedIn Discussion Group, “Even if you have real estate and contract experience, it’s current market knowledge that will be invaluable. And being in the trenches every day is the only way to be current.”

Today, it is critical for top corporate executive to provide the company’s stakeholders with only the best financial decisions to ensure maximum profitability. Yet, a small business or corporate executive is not an expert on negotiating leases for commercial real estate. A professional advisor can help the tenant best determine the answer to questions such as:

·         How large should the leased facility be to need the tenant’s needs?

·         Exactly what configuration of space bets suits the business’s needs?

·         What interior improvements need to be performed and who will pay for these changes?

·         What is the best length of lease term is optimal for the tenant?

·         Should the tenant secure rights for expansion or consolidation?

·         What other options should be negotiated into the lease?

·         Can a period of free rent be rolled into the negotiations?

·         Is the landlord and building in good financial condition?

·         Should relocation be seriously considered?

The owner of the commercial real estate being leased would probably quite pleased if the leasing business does not want a tenant representative because negotiations will likely be very easy and the landlord will get options that benefit them rather than the business. Daniel Rudd, Executive Vice President and Office Broker at Colliers International states, “It is short sighted for a tenant not to have representation and the tenant is ceding the landlord an incredible amount of leverage.”  With a broker, the tenant can be assured they have someone fighting for their right and making sure their best interests are covered. 

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Commercial real estate tenant improvements (TIs) have always cost a lot, but you would think that with the real estate market as a whole slowly marching back from the worst overall recession since the 1970s that some discounts would be available. This has not proven to be the case at all; in fact, costs for TIs requested by new tenants has taken a significant upturn during the first two quarters of 2011. What is driving this trend?

Misconception Regarding Labor Costs: One matter that causes people to think TIs should be flat or decreasing in cost is the fact that the commercial and private real estate markets went flat or, in some areas, sank into chaos. Unfortunately, the price or availability of real estate has nothing to do with the cost of workers that must be hired in order to perform tenant-requested modifications to a commercial real property. While there are plenty of workers available, the minimum wage for even menial tasks has risen and the cost of skilled labor has remained the same or increased due to average wages in a given market. In no case has the cost of construction labor, especially skilled labor, been reduced by the economy. A fair wage remains a fair wage and when a licensed contractor is required to perform work, that contractor requires a labor payment sufficient to cover his or her own pay as well as those people who must be hired to perform the tasks involved in the upgrade. As has always been the care, the more education, licensing, insurance, bonding, and other requirements that must be met by a legally operating skilled labor contractor, the higher the costs passed on to the property owner and, in the end, to the tenant paying for TIs.

Cost of Material Increases: As the economy rebounds, it seems that inflation is sneaking its ugly nose into everything everywhere. Even though salaries may not be increasing, costs are definitely on the rise. Donald Miller, a Central Texas contractor stated, “My cost for steel studs and related materials (used in TIs) have almost doubled during the first quarter of 2011. I’m not sure what caused this jump, maybe it is inflation, but I still have to pay the higher prices when I purchase materials to do my work.” Miller, like all other contractors, has no control over the cost of materials that must be included in job bids for TI work or any other type of work and it is only because all contractors are faced with this same increase that bids remain competitive. It isn’t just Central Texas that is facing these increases. Kenny Thompson of Thompson Concrete Construction, a Central Florida contractor, states, “I have to purchase lumber and steel for my jobs and I’ve noticed a sharp increase in the materials for what jobs that are available for RFP in the area in the last few months.” This impacts new commercial real estate, residential, and TIs – all phases of the real estate market and makes costs inch up.

Reverse Impacts of Poor Economy: Two years ago when the economy in the U.S. took a huge hit, many manufacturers of materials used in TI construction work had to lay off employees and reduce their inventory to bare-bones levels. Some companies had to close their doors completely, leaving holes in the manufacturing of some areas and resulting in shipping costs to move materials from regions still producing or having on-hand inventory. This means that premium prices are required by the construction supply companies because of reduced inventory on hand or higher shipping costs being rolled into the price of materials.

So while the “reasonable” person would expect TI cost to be lower, reality is quite the opposite.

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When leasing commercial office space to house your business, you may be lucky enough to locate a space that is just perfect for your needs without a single change. That, however, is not usually the case and changes may be required to fit the office space to your specific requirements. Before beginning any negotiations, it is important to understand two key terms:

Tenant Improvements (TI): This term refers to the construction or remodeling of leased commercial real estate that are made to accommodate the needs of the lessee. This could include adding or removing interior walls, signage, lighting, wiring, flooring, or other changes needed. The cost of these changes is negotiated between the landlord and lessee and agreement must be reached as to which party will pay for exactly what expenses.

TI Workletter: This is a written legal document negotiated between the landlord and lessee that outlines exactly what office building standards are used in any TI construction and the number of items supplied in the leased space such as light fixtures, power outlets, and other items required to make the space suitable for the lessee. The document also outlines how much the landlord will pay and what financial responsibilities on the part of the lessee may be.

TI Workletter Issues:

The Tenant Improvement Workletter may include:

• Exact descriptions of the TIs to be built
• The design process to be followed
• Contractors or other parties that will perform the TIs
• Who will pay for what improvement
• A clause regarding changes the tenant may want to make after initial design
• Definition of what happens if TI work delays result in impacts to the tenant move date

Scope of Work and Changes in Scope

The landlord’s architect, planner or designer prepares plans and specifications defining the TIs to be performed. Because the landlord likely owns the entire building, he or she will control this work because of potential impact of the TIs on the building or building infrastructure. The tenant should be consulted and involved in the process and a time schedule should be agreed upon. The landlord may agree to pay for certain basic improvements but if the tenant wants to make upgrades from the building standard, the costs will be levied on the tenant. Tenant requested changes are usually paid for by the lessee. If the lessee requests changes in mid-stream, the change in scope will be at their expense and may impact the move in date without any penalty on the part of the landlord or construction team.

Construction Phase

The landlord will normally be the party in charge of obtaining bids for agreed upon changes, selecting the contractor and obtaining permits, as well as managing the work and ensuring that as-built drawings are prepared. However, should the tenant be permitted to perform the TIs, he or she will be required to take care of all items above plus obtain payment and performance bonds and obtain lien waivers from all parties working on the commercial office space.

Payment for Tenant Improvements

The workletter must specify exactly who is responsible for paying for the TIs and how much will be paid. In some cases, the landlord will agree to a “turnkey” TI where all costs are absorbed by the landlord for the initially agreed upon improvements. Leases commonly provide a tenant improvement allowance stated in an amount per square foot rented and in this case the landlord pay the allowance and the tenant pays for all improvements. The workletter must outline exactly what the allowance can be used for such as planning, permits, and construction, as well as what can not be upgraded with the funds from the allowance, often items such as telecommunication wiring, trade-specific fixtures, and equipment.

Work Delays

This portion of the workletter should address exactly what happens if the facility is not ready for tenant occupation by a defined move in date. Usually the landlord does not have any financial liability because of late delivery and the lease normally remains in effect during any delays. If the delay is caused by the tenant, there is no reduction in rent due. However, the tenant should pay close attention to workletter clauses regarding delays and negotiate a better outcome if the delay in work is not their fault. There may be consequences negotiated into the workletter that result in contractor penalties or rent abatement if the delays are in no way caused by tenant delays or tenant requested changes of scope.

This is one of the areas that a good tenant representative will take the lead on assist you. Understanding the 'norm" in your are is important to make sure you get as much of an Office Space Tenant Improvement allowance as possible.

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The Tenant Advisor Blog has a good Infographic of key office lease issues. These are some of the most important office lease issues that need to be considered when signing a lease... after the price and business points have been negotiated and agreed upon.

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National Office Update & Office Tenant/ User Strategies PodCast
Original Air Date:    4/2/11

Very informative broadcast about the office market and office space strategies for office space tenants.

"The office user show provides a national office market update and best practices for corporate office users. Chris Macke, Senior Real Estate Strategist with CoStar Group provides an update on national office market performance including top cities for investment and markets prime economically for corporate headquarters. He also shares market advice for office users and expectations for 2011 and 2012.

Show host Michael Bull and industry leading guests cover current topics important for office users including strategic lease provisions for tenants, protecting lease rights before foreclosure, prevalent lease situations in this economy and the guests share best practices when renewing leases and securing new locations.

If your company uses office space or you advise companies that do, you will find this show very informative and enlightening."

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