Low Rental Rate = Great Deal…Right?
Rental Rate is Only Piece of the Total Costs a Tenant Pays.
Several other factors need to be taken into consideration when negotiating a lease, do you know what they are?
In an office lease, the rental rate is only part of the total costs that a tenant pays. There are other factors that can have financial implications over a lease term. These factors could create a much different picture of a Landlord’s proposed deal. So, rather than concentrating solely on rental rates, tenants should utilize a comprehensive approach when analyzing and comparing properties. These issues should be addressed in the earliest stages of the lease process, and should be carefully outlined in an “RFP” (Request for Proposal).
The following examples illustrate how some of these factors can have a significant impact on the “total occupancy cost” of a lease:
The Tenant Improvement Package
Understanding “TI” (Tenant Improvements):
When commercial office leases are negotiated, new construction or renovations are usually required prior to the tenant taking possession of the space. Typically the tenant improvements are funded by the landlord as a part of the rental cost – that is, the tenant pays for the improvements as a portion of their rent over the term of the lease. In both new buildings and in second-generation space, the landlord will determine the amount of rental income they hope to achieve and how much money they are willing to spend to build-out the space. A prospective new tenant or tenant renewing an existing lease should make inquiries early in the process to determine how much a landlord is willing to spend. This number is usually expressed in terms of dollars per square foot.
If the actual renovation cost falls short of the allowance offered, the tenant can negotiate with the landlord to offset all, or a portion of the savings, against their rental rate, or it can be taken as free rent for a specified period of time.
On the other hand, should the allowance fall short of the actual cost, tenants should require landlords to state in their proposal, their willingness to amortize the overage at a specified rate.
Space Planning and Construction Document Fee:
Landlords will typically deduct space planning and construction document fees from the tenant improvement allowance, thereby reducing the available construction allowance. Tenants should require a separate allowance for the space plans and constructions documents.
Base Building Improvements:
Another important factor regarding TI is the landlord’s definition of “base building improvements”. The base building addresses the construction work that is to be done to a space prior to utilizing the tenant improvement allowance. The base building definition varies from building to building, and it is vital that tenants require prospective landlords to clearly state their definition of base building in their proposal. It is equally important that they also define terms such as “above or below ceiling allowance” and “slab-to-slab allowance”.
Many times an owner will take care of the “above ceiling” construction, in addition to the base building construction, and they will give the tenant a “below ceiling allowance”. Below-ceiling TI allowances typically begin below the ceiling grid and cover walls, carpet, millwork, etc. All construction “above the ceiling” is paid for by the Landlord.
But, if a tenant is offered a slab-to-slab allowance, they are responsible for the construction above and below the ceiling that is not covered in the base building. This could be a problem because the base building could be so minimal that they end up spending their allowance on basic items that should already be covered by the Landlord. Again, these terms vary from building to building and need to be quantified early in the process.
Contractor & Construction Management Fees:
General contractors charge a contractor’s fee, which can range from 4% - 15% of the construction based on the size of the job. Landlords commonly charge an additional fee of 3%-5% to “supervise” the work of the contractor. These fees are negotiable based upon the transaction. Tenants should carefully examine any fees that are included in a transaction in order to avoid paying unnecessary “add-ons”.
Space Measurement:
Tenants pay rent based on the rentable square footage of a space. However, what you pay for and what you can use are typically not the same. The rentable square footage represents the amount of square footage a tenant physically occupies plus a pro-rata share of all common areas. Examples of common areas include restrooms, public corridors, elevators, and lobbies. The usable square footage of the space, often defined as the “carpeted area,” is the square footage the tenant physically occupies.
The only way to attain the best deal is to determine the building’s load factor and compare the actual usable rate per-square-foot of each property. The smaller the load factor, the greater savings for the tenant. Once you determine this rate, you can compare each building’s efficiency. For example:
In Summary
Tenants should avoid choosing a space based on its “sticker price”. The components described in this article are just a few that can have a significant impact on the total cost of the lease transaction. Additional factors that require careful consideration are:
Operating expense pass-throughs and annual rent increases
Parking expenses
Common area charges
After-hours HVAC charges, etc.
Again, these factors should be addressed early in the RFP. A carefully prepared RFP will help to uncover potential “deal breakers” and help prevent costly surprises down the road.
