Tenants Guide To Interior Improvements II

Continued from: Tenants Guide To Interior Improvement - Part I

Cash Flow: Getting the Allowance Disbursed Timely

Landlords (and their administrative functions) seek to strictly control the review and approval process for disbursements. Delays in that disbursement process can prove very frustrating for a tenant managed build where the construction contract is held directly by the tenant.

In negotiating applicable work letter terms, you should provide a lead-time for payment of no more than 30 days from the date of your monthly disbursement request submittal to landlord. Contractors will typically agree to allow a parallel 30 days between their invoicing and pay cycle. Also, it is imperative that the work letter be absolutely clear on:

  • How the allowance gets paid - to tenant or to the contractor, and
  • What supporting documentation (invoices, paid or unpaid; lien waivers - final or conditional; architect certifications, etc.) is required before landlord will approve disbursement requests and release the allowance monies.
  • How much of the total allowance can be applied against soft costs, or perhaps even used as a rent credit if not fully spent.

Be cautioned that your cash flow position can be very adversely impacted if there is long lead to recover an allowance disbursement from your landlord after you first have to pay the contractor(s) upfront on a respective invoice.

Landlord required retentions and holdbacks on disbursements, pending architect certified completion of the entire project, are also an important term to watch out for. You should not agree to more than a 10% retention (industry standard) by landlord, since you can often get parallel treatment in your contract with the general contractor. Again, from a cash flow management perspective, you’ll want to carefully avoid being out of pocket on any retainage differential as against what the contractor must be paid as the work progresses.

Extracting Value With a Construction Manager

CMs provide specialized competency and will work closely with your architect and engineer toward getting the greatest “bang for the buck” via “value engineering”, continuous process monitoring, and the CM’s up to date knowledge of market comps (pricing) for similar projects and components of the build. The benefit of a CM is perhaps most apparent in a tenant managed buildout, but a CM can also add considerable value in the case of landlord managed build. Sometimes larger architectural firms and lease brokerage companies have the capability to provide competent CM services, but that is not always the case, nor are their interests necessarily fully aligned with your tenant agenda. Independent CM consultants are typically compensated on a fee for service (hourly consulting fee), fixed fee, or price per square foot (from approximately $1.50 to $2.50 per rsf, depending on the size of project). While the CM could be compensated on a percentage of the total hard cost budget, this is generally not recommended due to potential conflict and adverse incentive

Turnkey Buildout: Expectations Likely Not Met?

Just because the landlord has agreed to do your interior buildout as a "turnkey" (with all pricing risk on the landlord) does not mean you have the comfort of thinking you are thereby free of worries concerning buildout of your space. Though, the one exception here is if the landlord has previously built the space "on spec", and you've carefully confirmed by on site visit that it suits your needs as is.

Tenants are strongly cautioned to be diligent in carefully and specifically documenting expected improvements and buildout specifications in the lease workletter. Probably the best way to achieve this end is by attaching fairly detailed space plans (construction drawings, if at all possible) with agreed specifications as an exhibit to the lease before signing. Note that it may not be practical to expect that full construction drawings will be completed and attached to the lease before lease signing in a turnkey scenario. This is because landlords generally will not incur that level of upfront design expense on “spec” without having a “locked tenant” pursuant to a signed lease. Conversely, the risks for a tenant agreeing to just attach a simple “test fit” space plan to the lease (to define the delivered turnkey build) can include many frustrations and unexpected negotiations as the build progresses, as well as significant disappointments when that space is completed and delivered.

Watch Out for "Gotchas"

As previously noted, there are many potential cost and timing traps for the inexperienced tenant concerning the buildout process. A few examples:

  • ADA compliance of bathrooms and common areas (and related costs) are of special importance for medical practices.
  • Change orders to approved plans can cause substantial additional costs and delays that will be on tenant’s “watch” (deemed a tenant delay) and at tenant’s cost.
  • For certain properties (retail, industrial) the obligation and cost for systems/HVAC maintenance and replacements are typically 100% on the tenant, as are the costs for utility taps, service connections, and meter installation.
  • Loading for safes and high density filing systems can require expensive floor reinforcement.
  • Asbestos abatement or encapsulation (this should be a landlord expense) in older buildings.
  • LEED certification requirement by landlord for interior buildout.
  • Landlord required performance bond (to be avoided wherever possible) add about 3% of total hard costs.
  • Removal and restore obligations at lease end mean potentially unbudgeted costs for the tenant. Landlords want the space to be more suitable for the next tenant’s use and buildout. Thus, they will likely require tenant’s removal (at tenant’s sole expense) of telecomm and computer cabling, SCIF space, staircases, training rooms, raised LAN room flooring, and other custom installations for unique uses, etc. These tenant obligations should be clearly spelled out and properly limited.

While perhaps best left to a discussion for another article (please see my separate article entitled - "Tenant Strategies and Opportunities on Lease Renewal"), you are cautioned when negotiating rental renewal rates that such rates should not continue to include a TI allowance load after the full amount of that allowance has already been recovered during the initial term. Landlords commonly seek to provide an express rent “floor” in the lease language that renewal rental rates can in no event drop below the highest amount of rent payable during the initial term. Unless there is a new allowance forthcoming as a quid pro quo for the renewal term, then the renewal term rent amount should be net of the original TI allowance amortization and related interest load.

Conclusion

There are many diverse issues, concerns, and details that arise when negotiating lease provisions for the initial buildout of your space. Many prospective tenants find the process unfamiliar, if not daunting. A failure to adequately attend to these important lease points can result in headaches, frustrations, delays, and unexpected (and unbudgeted) costs even before you’re able to move into your new space. Remember that your lease is a foundational transaction for your business that will impact your operations for a long time to come. It is essential that you have the benefit of a seasoned commercial lease broker experienced in tenant representation, as well as competent commercial leasing counsel, when negotiating and entering into a new lease. Many business generalist attorneys will claim that they also “do leases”, but only an attorney that consistently and regularly negotiates leases will know the industry and practice sufficiently to provide you adequate counsel for such an important transaction for your business.

Lars Andersen is an independent practice attorney with over 23 years experience in commercial leasing and a wide variety of business transactions. Lars may be reached at 703-349-1251, and via email at [email protected]. He would be happy to discuss your planned transaction. Please note that the above article is informational only, and should not be construed as legal advice with respect to your situation or matter – if such advice is required the services of an attorney should be engaged.

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