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: turnkey build-out and tenant improvements, which share the risks and the costs a bit differently. We will understand the differences between the two in terms of the basis of expenditure.
Turnkey Build-Out Vs Tenant Improvement
Turnkey Build-out Definition
The first way to finance workspace retrofit is turnkey build-out. In this project type, 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.
Tenant Improvements Definition
The other way of financing retrofit is tenant improvement. The occupant is largely responsible for carrying out all the necessary retrofits. 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 occupant’s perspective, this is a convenient option. However, one must carefully consider if all the needs of the business are met.
The default turnkey project may include only the bare minimum basics such as drywall, sound-absorbing 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 turnkey project negotiation usually involves hiring 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 they may accept to bear the expense. If the cost estimates are too high, often they will negotiate an increase in the rent or lease amount.
It is also possible that the landlord may also agree to pay only the set amount of the turnkey project and ask the occupant to pay anything over that. Then the responsibility of hiring a commercial general contractor and implementing the negotiated plans lies with the landlord. They are also responsible for handling any regulatory requirements such as permits and building certifications for the turnkey project.
The lease period usually begins after the retrofit is done and the tenant moves in.
Key Considerations in Turnkey Build-out
- One of the key considerations here in turnkey projects 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 them for the quality of the construction. However, it is in their interest to minimize the costs.
- On the other hand, the tenant has to face lesser risks in turnkey projects. Any regulatory issues or cost overruns are not their 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 in turnkey projects may hit the tenant financially due to the lost opportunity cost of all the delayed periods, 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, a turnkey project 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 commercial contractors. Such businesses may even have dedicated departments to manage their commercial property retrofit. Hence, they do not choose the turnkey project option.
Tenant Improvements
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 toward rent payments.
Depending on the negotiations and the contract, the tenant may be able to keep any leftover money from the tenant improvement allowance. This option is great for businesses whose needs will not be met by any generically outfitted commercial space. In tenant improvements, you will need to hire an interior architect to draft a workspace plan and get it approved by the landlord.
With tenant improvements, you will also need to take care of any regulations, safety protocols, and certifications. If there are any issues with the building foundation requiring any extra costs, then it is your responsibility as well. Then you can go ahead to hire a commercial general contractor yourself or get the landlord to hire one.
Often larger businesses have relationships or long-term contracts with general contractors who also carry highly customized tenant improvements to maintain uniform brand identity across all outlets.
Key Considerations in Tenant Improvements
- The key consideration for tenant improvement is the added responsibilities and increased upfront costs.
- Many medium and large corporations are capable enough to handle the added responsibility of tenant improvements and have strong credit lines to take care of the upfront costs.
- Another issue is that the time required for the tenant improvement contractor is not excluded from the lease. Hence, the lessee is essentially paying rent for construction time as well.
- Also, if there are any cost or time overruns by the general contractor, the lessee will need to deal with them.
Overall tenant improvement comes with added upfront costs where the lessee has to manage and oversee the construction, however, at the same time, it offers the lessee almost infinite possibilities, within regulations, to outfit the commercial space to suit any business needs. For this reason, tenant improvements are mostly preferred by national chains and large corporations. TIs may also be necessary if the landlord does not have the means or the time necessary to offer turnkey build-out.
Final Verdict
Turnkey build-out and tenant improvement allowance both are advisable ways of negotiating the building expenditure of your commercial lease space. If timing is an issue, then your business will require a space that has at least minimal improvements in place. In such cases, turnkey build-out is a recommended solution for tenants.
If as a lessee, you want greater control over the construction process and utilization of the TI allowance, then tenant improvements are an ideal solution for you. Most of the advantages and disadvantages of both turnkey projects and tenant improvement projects lie in the finer details of the contractual lease agreements. Perform your due diligence and strive for clear communication for lease negotiations.
Work with a tenant representation broker to score the best deal. A tenant representation broker will identify the potential effects of inflated costs and unfavourable lease terms on your commercial business.
FAQs
What is included in commercial tenant improvements?
Tenant improvements of a commercial building are for the interior and may include:
- Renewed interior layout and designs
- Mechanical upgrades such as plumbing, electrical, HVAC
- Replacing old lighting with new ones
- Flooring replacement
- Application of a new paint color
- New furniture, signage, countertops, and other upgrades
Should I buy or lease a commercial property?
For the long term, buying a commercial space will offer you more stability than leasing. Leases come with low-initial costs where you won’t be responsible for property maintenance and repair. Take your decision based on your unique business goals, financial standing, and local real estate market conditions.
Do turnkey landlords offer any warranties?
Yes, most turnkey providers offer warranties to repair defects in materials or workmanship for a specified period after the completion of a commercial project. Review the turnkey project contract for warranty provision; the longer the warranty, the safer the lease.
Relevant Resources:
- The Benefits of Construction Manager/General Contractor Services (CMGC) versus Design-Build Project Delivery
- How Your Commercial General Contractor Can Help Reduce Costs
Constructive Solutions, Inc. is a full-service commercial construction company serving San Francisco and Bay Area.
Whatever your vision, we have the resources, experience, and insight to make your concept a reality, and a space where your business can flourish.
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