When a business decides to move into a new property, often renting commercial space is the most common route for most small to medium-sized businesses.
When it comes to renting space, oftentimes the commercial property will not have the necessary outfitting. It may be empty, or the workspace layout for the previous tenant may be unsuitable or undesirable for your needs.
Hence, it is almost inevitable that you will need to have a comprehensive retrofit of the workspace to suit your business. There are two common ways to do that, which share the risks and the costs a bit differently.
Main difference
The first way to finance workspace retrofit is turnkey build-out. In this scheme, the property is delivered to you in essentially a ‘turnkey’ way, that is, ready to be used immediately as you turn the key to the property and start using it. The landlord carries out the retrofit and the cost is added to the rent or lease amount.
The other way of financing retrofit is tenant improvement. The tenant is largely responsible for carrying out all the necessary retrofit. There may be a negotiated tenant improvement allowance paid out by the landlord towards the related expenses.
Turnkey buildout
Most landlords leasing out commercial spaces offer turnkey build-out options. From the tenant’s perspective, this is a very simple option. However, one must carefully consider if all the needs of the business are met.
The default turnkey option may include only the bare minimum basics such as drywall, sound-absorbent ceilings, basic flooring, plumbing, and some electrical outlets. Obviously, this is hardly sufficient for most businesses.
In case you need more options to be included in your retrofit, you will need to negotiate so with the landlord. The negotiation most commonly involves getting an interior architect to draw up an internal layout suitable for your business and work environment. Then a cost estimate based on that plan is calculated. If this cost estimate is acceptable to the landlord, then he may accept to bear the expense. If it is too much, often an increase in the rent or lease amount will be negotiated.
It is also possible that the landlord may also agree to pay only the set amount and ask the tenant to pay anything over that. Then the responsibility of hiring a commercial general contractor and implementing the negotiated plans lies with the landlord. He is also responsible for handling any regulatory requirements such as permits and building certifications.
The lease period usually begins after the retrofit is done and the tenant moves in.
Key considerations
One of the key consideration here is that the lease or rent amount is usually higher. Also, if you go with whatever the landlord is offering, you will have to rely on him for the quality of the construction. However, it is in his interest to minimize the costs.
On the other hand, the tenant has to face decreased risks. Any regulatory issues or cost overruns are not his problems. Any delay in completing the construction also should not be a problem since the lease period starts only after the construction is completed.
With that said, construction delays to minimize cost may hit the tenant financially due to the lost opportunity cost of all the delayed period, for which the landlord does not need to compensate. This typically leads to lower upfront costs but a larger cost of the rent. Depending on the type of your business finances, this may or may not be a good option for you. Smaller and medium businesses often prefer this option since they need to have fewer responsibilities. However, larger businesses such as nationwide restaurant chains may have a comprehensive set of requirements and even permanent contractors. Such businesses may even have dedicated departments to manage their commercial property retrofit, and hence they do not choose this option.
Tenant improvement
The other option for financing workplace retrofit is tenant improvement.
In this method, most of the responsibilities, as well as the costs, are handled by the tenant. Depending on the lease agreement, the landlord may pay some amount of ‘tenant improvement allowance’ towards workspace retrofit. This payment may be made in the form of direct payment to the tenant, payment of construction costs, or credit towards rent payments.
Depending on the negotiations and the contract, the tenant may be able to keep any leftover money from the allowance. This option is great for businesses whose needs will not be met by any generically outfitted commercial space. In such cases, you will need to have an interior architect draft a workspace plan. Then you will need to get this plan approved by the landlord.
You will also need to take care of any regulations, safety protocols, and certifications. If there any issues with the building foundation requiring any extra costs, then it is your responsibility as well. Then you can go on to hire a general contractor yourself or get your landlord to hire one.
Often larger businesses have relationships or long-term contracts with general contractors who also carry customized furnishings to maintain uniform brand identity across all outlets.
Key considerations
The key consideration for tenant improvement is the added responsibilities and increased upfront costs.
Many medium and large corporations are well equipped to handle the added responsibility and have established credit lines to take care of the upfront costs.
Another issue is that the time required for the general contractor is not excluded from the lease. Hence, the tenant is essentially paying rent for construction time as well. Also, if there are any cost or time overruns by the contractor, the tenant will need to deal with it.
Overall this method comes with added upfront costs and also the tenant will have to manage and oversee the construction, but it offers the tenant almost infinite possibility, within regulations, to outfit the commercial space to suit any business needs. This is common for many national chains and large corporations, but may also be necessary if the landlord does not have the means or the time necessary to offer turnkey build-out.
