I get asked a lot of questions about real estate, but one question never stops coming. It is asked by my clients, tenants I meet with, and other brokers in my office, “Should I get an allowance and build out my own space or should I just have the landlord build it?” It is a loaded question and the circumstances dictate the proper solution.
There are three likely methods to handle Tenant Improvement construction: 1) Build to Suit; 2) Landlord Build; and 3) Tenant Build. The second and third scenarios will usually include a Tenant Improvement Allowance ranging from $10.00 to $75.00 per square foot leased. The actual language negotiated in a lease for any of these options can very widely, and can be found in the Workletter portion of the lease.
“Build to Suit” implies that the landlord will build the premises to suit the Tenant’s needs. It is very typical for smaller tenants to choose this option, but is also used by sophisticated large corporate users (typically for accounting and risk mitigation reasons). It is a great option for the tenant that does not want to deal with all of the headaches involved with managing construction, but the tenant does need to be engaged to get the benefit of its bargain.
The “Build to Suit” or “Turn Key,” as it is sometimes called, comes with a few caveats and is typically tied to an agreed upon set of plans. Having a detail orineted broker or PM at your side during the space planning and leasing stage is necessary to make sure this option delivers the desired results. Some tenants and brokers feel like they leave a lot on the table when choosing the build to suit option and that the landlord has too much control over the process. I agree, but think it depends on the scope of the project.
“Landlord Build” is the middle ground between a Build to Suit and Tenant Build. In this type of Workletter the landlord builds the space for the tenant, but the landlord’s exposure is limited to the amount of the Tenant Improvement allowance. If the Tenant improvements in question are well designed and priced beforehand to fit within the Tenant Improvement budget, this option has an outcome similar to the Build to Suit.
The reasons for choosing this option over a Tenant Build Workletter include those mentioned above, but most often are for accounting reasons (The tenants amortization period starts when the tenant takes possession of the space. If the landlord builds, the tenants amortization period can be delayed until they take occupancy.) or when the landlord is in the midst of constructing the core and shell of a new building and does not want a different TI contractor in the building while finalizing construction. This is the only workletter method where a construction management fee can be justified by the landlord (although I still like to eliminate any landlord fees during construction).
“Tenant Build” is the Workletter choice that provides a tenant the most control (and risk) over its Tenant Improvement (TI) outcome. A TI Allowance is typical and the tenant will be able to use this allowance for project management fees, architectural fees, permits, furniture, hard construction costs, and in many cases the unused amount can be used to offset rent. It is typical for a tenant with highly specialized TI needs or extremely architectural / high end space to choose this type of Workletter agreement. Unless the tenant has an in house real estate department with construction expertise, a PM (Project Manager) is typically engaged to manage the process from space planning through final move in and punch list.
There are many nuances with all three options and each option requires careful planning and monitoring. Strict timetables for approvals are put in place to insure neither party delays the process and safeguards are put into the lease to make sure the landlord has the wherewithal to deliver the negotiated TI allowance. The right choice for you will depend largely on your circumstances and also the credibility and experience of the landlord involved.