As the economy continues to expand (along with office tenants), office construction costs continue to climb. That’s due in large part to the strong economy as well as a shortage in construction labor and certain materials. In this post, I outline strategies for tenants to minimize their office construction costs. Thank you to Bill Conopeotis and Liz McCleary of ConopCo Project Management for their input on this post as well our long-time client Erik.
Before I get into these strategies, I’d like to briefly discuss what items are included in construction costs. By construction costs, I’m referring to the hard construction costs, i.e., labor and materials including audio-visual. In an office move, there will be many other significant costs: Soft Costs such as professional fees (including increasingly for “branding”), Furniture, and Technology. Here’s a typical allocation of these costs including a contingency.
- The Right Team. It’s key to assemble the right team that can flesh-out the tenant’s goals, develop a strategy and execute. Key players on this team are the tenant representative, project manager and architect. Where a tenant has unique mechanical requirements, an engineer may be added to the team. Note, on smaller projects including “turnkey” projects (see below) or where the tenant has in-house expertise, the scope of these team members may be less or not needed. Beyond firm names, who are the project team individuals? What is their current work-load? Do they have any recent relevant success that they can point to? Importantly, do they click with the client? It’s important to have this team employed early in the process while buildings are being evaluated. After options are narrowed, save money and time and bring along on the site visit the project manager, architect and possibly a general contractor. Those extra sets of eyes can spotlight issues for the tenant and its advisor to negotiate while the tenant is in a position of maximum leverage.
- Space Program & Project Budget. Before even looking for office space, the tenant should work with its representatives to develop a space program to define how much space it will need and the key components. For example, it would be a costly surprise to underestimate one’s technological infrastructure requirements. For non-turnkey projects and based upon a space plan coupled with a detailed narrative scope of work to define design intent, tenants should engage a general contractor to provide cost estimates which will be continually refined throughout the process.
- Turnkey. In a “turnkey” construction project, the landlord constructs the space at its sole cost based upon the plans and specifications agreed upon by tenant and landlord. Note, it is common for the landlord’s architect to develop the drawings based upon the plans and specifications; however, the tenant should have someone on its team to review these drawings for approval and construction. If the landlord and its team have a proven track record and there are detailed plans and specifications, this “turnkey” approach will not require the tenant to directly pay for any construction costs or any architect or engineering fees. Instead, those construction costs are embedded into the tenant’s rent and the tenant is leveraging the landlord’s buying power with the contractors. Tenants may find that the trade-off to this approach is that they give-up some control of the process. Another trade-off is that any subsequent changes requested by the tenant can be costly. To learn more about the pros, cons and how to successfully navigate this strategy, please see my post Tenant Improvement Strategies – Turnkey Approach
- Maximize Tenant Improvement Allowance. Unlike turnkey construction projects, the landlord provides the tenant with a cash allowance (i.e., Tenant Improvement Allowance) to construct its offices and they may be able to apply that to Soft, Furniture, and Technology costs. In addition to negotiating a large cash allowance to address the anticipated construction costs while tenant is negotiating with multiple properties, it is important that this allowance is not diluted to fund costs (e.g., life safety) which should be borne by the landlord which is referred to as “Base Building Work”. At times, newly constructed buildings can be lacking in this area and tenants end up with higher costs. To avoid the Base Building pitfall and others, please see my post – Tenant Improvement Strategies – Allowance Approach.
- Looking “Under the Hood”. Where construction is being performed on an allowance basis, some of the biggest cost surprises to tenants result from inadequate building infrastructure. For this reason, it is important early-on in the process for a tenant to have its team assess these matters (e.g., mechanical systems, HVAC, electrical). If caught early in the negotiations, the tenant has a better chance of pushing these costs to the landlord where they should be allocated as they are more capital in nature (as opposed to tenant driven improvements). The corollary is that a well-documented turnkey construction approach will push these infrastructure risks to the landlord.
- Recycle Existing Improvements. As to previously constructed spaces, it may be possible to reuse some existing tenant improvements provided that they are in “like new” condition. In addition to the reduced environmental impact, there may also be a financial benefit. That, of course, is not always possible, particularly for larger corporate tenants with national standards.
- Big Ticket Costs. Office tenants can expect to spend the most on electrical, telecom and mechanical (HVAC). As technology advances with more cloud-based systems, we are seeing fewer requirements for supplemental HVAC for tenants’ server rooms. On the other hand, we’re seeing some high-end audio-visual requirements approach $20/sf.
- Innovative Construction. With the steady supply of new construction products, there are a growing number of products and materials that can create the desired look at a lower cost. For example, vinyl flooring that resembles wood and even polished concrete. Tenants today are looking for more collaborative, light-filled space while at the same time wanting to provide for some enclosed offices to offer space for privacy and concentration. To achieve this more cost effectively, we are seeing smaller interior private offices which have glass windows at the top of the walls or along the side of the door to allow natural light.
- Industrial Chic, Ain’t Cheap. A major misconception among tenants is that the industrial look (i.e., open ceiling and concrete floor) will be less costly than traditional ceiling tiles and carpet. While this look fosters a sense of openness and transparency, it is costly to retrofit the areas above the traditional ceiling grid to be fully exposed. Those renovations include replacing ductwork, spraying the underside of the deck, adjusting sprinkler systems as well as telecommunications trays. Just as the area above the drop ceiling was not intended to be viewable, the concrete floor requires leveling and layering as well as finishing to create that polished look. One of the downsides of the concrete floor is that touching up any surface scratches creates a challenge when trying to match the same polished look. Another concern, which can increase costs, are acoustics. An open ceiling and a concrete floor allow sound to travel. Adding acoustical panels to furniture additions as well as additional sprays to the deck will help with the acoustics but will also increase costs. Some tenants also employ sound masking to create white noise which doesn’t limit the sound, but it adds another layer of sound.
- Coordinate with Furniture. To avoid wasted or misplaced outlets, the furniture plan should be in place and agreed upon. Having to core drill for additional outlets after construction can be quite costly.
- Detailed Drawings. To fully yield the fruits of a competitive bidding process for an Allowance project, tenants should have their architect and engineers develop detailed drawings. As subcontractors are 90% of the total Hard Costs, it is important that the bidding subcontractors have comfort on scope and timing. Otherwise, the subcontractors’ bids will be inflated to cover a vaguely defined plan and timing. Likewise, detailed drawings are important for a Turnkey project as any ambiguity will likely result in a higher rental rate and lead to change orders for the tenant.
- Schedule. As a significant portion of the construction budget is labor, a well scheduled project that efficiently sequences the subcontractors will save money by shortening the project duration. With a shorter schedule, less time means less cost to the general contractor. An efficient schedule allows the subcontractors to aggressively bid.
- Regular Site Visits & Project Meetings. Frequent job-site visits and meetings help avoid the inevitable construction drawing interpretation and execution issues. These regular visits and meetings forge a good working relationship with the contractors which will help minimize any change orders and keep the project on schedule.
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).