While many lease provisions never come to light for tenants, there is one that all tenants face after the lease is signed: the Tenant Improvement Provision a/k/a “Work Letter”. Given the amount of dollars at stake and its operational significance to the tenant, it requires the utmost attention. The Tenant Improvement provision often falls into a gray area of lease negotiations as a portion of it can be classified as “business terms” while the other parts of the provision can be viewed as “legal terms”. As a result, many tenants neglect the importance of this provision which is practically facilitated by landlords whom usually bury it at the end of the lease or as an exhibit. From 20 years of reviewing and negotiating leases, I’ve learned to first start reviewing the Tenant Improvement Provision given its significance; but more importantly, I’ve learned that a successful Tenant Improvement strategy requires a coordinated effort by the tenant’s team at the beginning of the project.
Well before a tenant starts looking at buildings, they should develop a strategy for the tenant improvements. There are essentially 2 approaches: (1) “Turnkey” where the landlord constructs the premises at its sole cost; and (2) “Allowance” where the tenant is responsible for any construction costs exceeding the allowance provided by the landlord. Underlying both approaches is the economic reality that the tenant is ultimately paying for construction through its rent payments. Also underlying both approaches are the divergent interests of tenant and landlord which must be kept in mind. The landlord’s focus is maximizing return on its investment. While a long-term thinking landlord will want to foster a positive relationship with the tenant, the landlord primarily looks to minimize its capital outlay and collect rent as soon as possible. By contrast, the tenant’s interests are to have the space constructed meeting its business needs at the lowest possible cost and on a timely basis.
To successfully implement one of these approaches requires the tenant to have a competent team (project manager, architect and tenant representative), invest time in carefully assessing the buildings and spaces under consideration, the competency of the landlord (and its team) and to develop detailed plans and specifications for accurate preliminary cost estimates. To not invest adequate time and money as part of your diligence, will cost the tenant multiples in unforeseen costs and delays.
For each of these approaches, we will provide an overview outlining the pros & cons along with a suggested strategy to successfully implement. We also list some of the common pitfalls of each. The savvy tenant realizes the importance of the tenant improvement provision and that a mistake can be very expensive. Don’t be a penny wise, and pound foolish tenant!
Blackacre Advisors LLC
DISCLAIMER. Our writings are from a real estate transaction perspective and for informational purposes only. Nothing herein shall be considered legal, accounting, tax, or architectural advice. Please consult with the appropriate professional(s).