Expert: Jim Avancena, CPM - 2/26/2009

Question
QUESTION: Hi Jim,

I am not comfortable with the Tenant Improvements (i.e. the cost to build out the shell).  My reason being (1) this is not my property, (2) again this is not my property :-( (3) the landlord owns the building, and (4) I have no way of knowing what it will cost to finish their construction (i.e. I feel that this option is too-too risky for me the tenant), and (5) in my opinion what they are offering will not be enough to complete the basic fundamentals of the building (i.e. wall, ceilings, plumbing, hvac, finished flooring and etc).  So I think it makes sense for the owner to take full responsibility for building the space out per specifications that we can agree on for my business.   Given the fact that I have no way of knowing how much it will cost to complete their building with walls, ceiling, flooring, electrical, HVAC, plumbing and etc… and not mention problems that may be encountered if their construction to this point has unknown problems – I feel that it should be the responsibility for the owner to complete the space.  Am I being unreasonable and is it possible to get a building build-out by the owner.  Note:  This is quote.. 4,316 sf space quoted at $15.00NNN, $5.50 OpEx. and $20.00 TI.


ANSWER: ABOF-

As a prospective tenant, you will always be faced with determining if the landlord's offer is a "Market" offer in terms of the retail submarket area where you are interested in having a shop/store.  If the landlords at comparable retail properties are offering about the same economic terms to motivate you to lease space at their project, then you have to decide if you want to accept the overall economic deal being offered to you.

It is not a matter of the landlord owning the property and later retaining the value of the improvements you make to it when you initially move into your premises.  If you refuse to pay the costs that this particular owner is suggesting you pay, will he be able to find another tenant to accept the economic deal he is offering to you?  If your answer is yes, you must either accept is offer or find another space to lease.

The retail market is extremely soft right now so the landlord should be open to flexibility in his terms - especially if there is significant vacancy at his retail property.

It may be that the owner simply does not have access to the funds to provide you to build your premises the way you want it.  Times are tough for landlords too at the current time.

You must also consider if the landlord believes you have the retailing experience for him to risk putting up his own cash to build out your space.  Were you to go out of business six months after moving in, the landlord would be faced with having to tear out your improvements and rebuild your proposed premises for another tenant with a different type of retail business.  He would lose all the funds he had spent to build out your premises.  

You should check around with some other tenants that are in similar quality retail space in nearby shopping centers that recently moved in and try to get them to tell you what kind of lease terms they got in their lease deal.  This would give you an understanding of what local area lease terms have been and give you some ammunition to use when discussing what you believe "market" lease terms are now with the landlord.   If there is a large anchor tenant in the shopping center - like a grocery store or other chain tenant - call the chain's "facilities" staff at the home office and talk with the person that handled either the lease or who is managing their store they have at your shopping center.  Talk with them because sometimes those folks will give you some idea of what they think the market terms should be and will share those thoughts with you.  

You should ask some contractors to give you an estimate for doing all the improvements that you need to have done on the premises.      That is the only way to know if a $20/psf allowance is going to build what you need built, and how much more it will cost.   Do not trust the landlord to tell you accurate buildout numbers, especially if the landlord is going to do the improvements itself, or have a "friend" do it.

Note also that the landlord simply may not have the funds to build the premises out for you.   If you suspect that is the case, tell the landlord that you will build out your premises at your own cost, but that he will have to give you rental abatement for the first X amount of months rental which is equal to the cost of the improvement dollars you will have to spend up front.   Again, you will need to get rock solid estimates for your tenant improvements before you make your lease deal with the landlord.

If there is significant vacancy at the shopping center and you suspect that the landlord may be in financial trouble, you should ask the landlord to PERSONALLY guarantee the cost of your improvements until such time as your free rental has amortized the total value of your construction work.  You don't want to be left "holding the bag" if the property goes into foreclosure.

The only way to know if the deal is a fair market offer is to get some comparable leases to go by for a meaningful evaluation and some tenant improvement estimates that are "real".  Do not go by your landlord's estimate of value on the improvements.

Good luck,

-Jim


---------- FOLLOW-UP ----------

QUESTION: Hi Jim,

What is the industry standard regarding build-out/tenant expense (TI) on a space that has been previously rent and finished for the originally leasee.  Can a new leasee expect a (TI-Expense) towards getting the space per their layout requirement?

Thanks Again… ABOF


Answer
ABOF-

There is no industry standard regarding build-out allowance, however there may be a general understanding in your particular submarket based on the current fundamentals.

Simply put, it is a matter of how badly the landlord wants your business to enter into a lease with him.   That can vary depending upon numerous factors.   The landlord may be willing to give a larger allowance to Tiffany's than to Subway.

Check on some local market comparables regarding TI allowance being certain that your analysis includes the overall economic terms of each comparable, not simply the TI allowance.

Good luck,
--Jim