As the name implies under this approach, the landlord – at its sole cost – is responsible for all elements of construction based upon an agreed to scope of work. Many tenants are attracted to the simplicity of this approach, but if not properly structured and implemented can lead to unwanted financial surprises, delays as well as a space that is not constructed to meet their needs. Outlined below are the pros and cons to this approach, common pitfalls and strategy to successfully implement. It should be noted that national tenants with national construction agreements (e.g., carpet) can use this Turnkey approach by requesting separate allowance for this materials which if properly introduced should drive down the total costs resulting in lower overall rental rate.
- Landlord is responsible for coordinating the entire construction project (including all architects, engineers and contractors) which is an area most tenants lack in-house expertise.
- Landlord pays for all construction related costs, thus no capital outlays by tenant.
- Landlord bears risk if ultimate costs are higher than estimated.
- Landlord responsible for any “Base Building” deficiencies, i.e., uneven floor, curtain wall issues, demolition of previous improvements, etc…
- Landlord is responsible for obtaining all governmental approvals (including permits) and they may have more leverage than the tenant with the local governmental entities.
- Larger landlords typically have more buying power with contractors than the tenant.
- Timing of completion can be assured by linking “Substantial Completion” of construction to certain penalties under the lease, i.e., rent abatement, indemnification for holdover liability (if relocating from another building under an expiring lease) and cancellation.
- Better suited where the building or space has environmental or ADA issues where the landlord bears responsibility.
- Success of turnkey construction is dependent upon competency of the landlord and its construction team.
- If the tenant did not adequately define the scope of work and since the landlord’s goal is to minimize its capital outlay, the landlord may take advantage of those ambiguities and make decisions on the scope that are inconsistent with tenant’s goals or result in costly change orders for the tenant.
- Vague scope of work leads the landlord to be overly conservative with their estimate which then elevates the tenant’s rent (as the costs are being amortized over the lease term).
- If total costs are less than what was estimated, landlord keeps the savings.
- Not suited for specialized construction or where tenant lacks internal consensus on scope of construction.
- Time constrained project may result in landlord comprising quality to meet completion date.
- Vague scope of work serving as basis of turnkey commitment in the lease leading to costly “change orders” and inflated rental rate.
- Not defining technology and power requirements as electrical costs are typically one of the highest on a construction budget, resulting in costly change orders.
- Scope of Work based upon undefined building standard materials, or, worse, based upon “mutually acceptable plans and specifications” which is just an agreement to agreement
- Inexperienced landlord and construction team.
- Tenant not having internal consensus on scope of work.
- Not linking completion to the commencement of the lease term and penalties.
- Not coordinating the tenant’s furniture and telecommunication installation.
- Not addressing what happens in the event of a fire or other casualty prior to lease commencement date
- Financially questionable landlords, not having assurances (e.g., escrow) that they have capital to fund construction.
Successful Turnkey Strategy
- Landlord has the competency and financial wherewithal to complete the construction
- Tenant has internal consensus on the scope of work
- Tenant, by using its own architect and engineer, has developed a well-defined Scope of Work based upon detailed plans and performance specifications.
- Detailed Plans, depending upon the amount of construction needed, may include furniture, power & communications, and reflected ceiling plans.
- Performance Specifications, to correlate with the Plans, addressing demolition, partitions, doors, hardware, power & communications, lighting, ceiling, life safety, plumbing, HVAC, flooring, wall finishes, millwork.
- Short Cut – if this is the tenant’s branch office and they recently built-out a similar one, provide those construction drawings in conjunction with a space plan for this space.
- Even if the ultimate goal is to have the construction completed “turnkey”, in the initial RFP the tenant should request what allowance they will offer for the proposed term and rate. This will flesh-out the most viable buildings and landlords.
- After tenant has obtained initial proposals, for their top candidates (typically 2 or 3 buildings) tenant submits a counterproposal which includes a request for turnkey construction including Detailed Plans and Performance Specifications. Under the pressure of competition, the landlords will leverage their relationships with contractors to obtain the best preliminary pricing to provide tenant with the lowest turnkey rental rate.
- In the RFP and certainly in the counterproposal, tenant should link “Substantial Completion” of the construction to the commencement of the lease and include penalties for untimely completion of the work.
- “Substantial Completion” should be defined to include : (a) compliance with approved plans, other than minor punch list items; (b) compliance with all applicable laws; (c) the Building and common areas (including parking areas) being complete consistent with first class buildings in the area; (d) the HVAC, electricity, and plumbing systems serving the Premises are in good working order and operation and fiber optic cable service is available to the Premises; and (e) all required certificates of occupancy have been issued.
- After selecting the finalist and while tenant maintains the most leverage, in the Summary of Terms (or LOI), the tenant should introduce its suggested Turnkey Construction Provision (Work Letter) addressing:
- That full scope of work includes all construction drawings, engineering drawings, permits, etc…
- Development of the construction and engineering drawings to be based upon tenant’s attached Plans and Specifications and include an approval process for tenant.
- Change order mechanism, as there are almost always changes.
- 1-year warranty against defects in construction work and materials.
- Early Access period to coordinate install of tenant’s furniture, telecom and equipment.
- Regular construction progress meetings and/or conference calls.
- Punch List procedure.
- Designate someone from tenant and landlord that will make decisions on construction matters, plan review, etc…
- Mechanism to confirm Substantial Completion and account for construction costs where applicable to an early lease termination option.
- Clarify no move-in charges.
- After the lease is signed, be sure the landlord’s construction team has a copy of the construction provision (or Work Letter) as frequently they do their own thing and aren’t aware of how the tenant may have tailored the work letter.
- Tenant and its representatives should make regular inspections of the work and/or participate in weekly calls with the construction team.
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).