Stupid is Easy (and expensive)
In tenant-favorable market environments, landlords often provide more concessions to compete for tenants. Concessions come in many forms, the most obvious being, landlord funding for tenant improvements, free rent, reduced rent and more flexible lease terms. But understanding the value of the concession is not always easy, especially relating to tenant improvements, one of the biggest economic variables in leasing.
The cost of tenant improvements is less straight forward than rental rate because it’s usually not directly correlated to the actual cost to build the space. In most cases, it is expressed as a landlord funded tenant improvement allowance, or “TIA”. Understanding the real value of a TIA necessitates knowledge of the actual cost to design and build your specific space. Remarkably, occupiers often lack this critical knowledge before signing a lease. This creates risk and cost exposure. Today, design and construction of standard office space costs ~$200/sf, or $2M on a 10,000 sf space. Landlords are keen to negotiate this aspect of the transaction while the tenant is still ignorant of the actual costs. In the current San Francisco market, a standard TIA for a longer term deal would be ~$100/sf. Note this leaves the occupier with a $100/sf exposure in funding the full cost to build new space.
How can occupiers negotiate a more favorable outcome? The first step is to prioritize understanding cost and schedule relating to the design and construction of tenant improvements. This requires engagement of an architect and general contractor at the onset of the project. These experts should work “hand and glove” with the real estate advisor to test fit and develop basic space plans for target sites. Thought should be given to the construction and level of finishes necessary to build the optimal office. Test fit, planning and ROM budgeting should be undertaken for all serious site options. Yes, there is a cost to this effort in the form of programming, test fits and space planning. However, these are all costs you will incur, in any case. Our approach simply moves them to the front of the schedule, where the knowledge acquired can be leveraged for a better outcome.
You might be wondering why understanding the cost of construction remains largely outside the realm of the typical broker-led tenant advisory service? The reason is because acquiring this knowledge adds complexity and time to the transaction process, creating more risk and less profitability for the broker. This ties back to the misalignment of interests we’ve written about in the past. Stupid is easy, smart is not. If the leasing process seems simple, centered on finding a building and negotiating a “market” transaction, including a “market” TIA, maybe it’s time to consider a new approach?