The right commercial office space must attract and please customers. But in today’s hyper-competitive business environment, it’s just as important to consider where employees work. This article explores the importance of commercial office build-outs along with owners’ costs.
Commercial office tenants want workspaces that increase employee productivity and morale. What’s more, tenants want their spaces to reflect their brand and company culture. And they want spaces that help attract and retain high-performing employees. This has created a “flight to quality”. Currently, landlords need to offer more amenities and more flexible spaces for commercial tenants.
Commercial real estate experts expect 2019 to be the fourth consecutive year with more than 50 million square feet of new office completions nationwide. Much of that space needs to be built to the renter’s specifications.
In the office leasing and retail space world, the term ‘office build-out’ (or ‘fit-out’) refers to the process of finishing raw commercial spaces.
Usually, this consists of just four walls, concrete floors, and a door—to meet the needs of a specific tenant. Typically, we express the cost of commercial building construction or build-out in terms of the average cost per square foot.
The typical commercial lease term is three to five years. And like everything in business, the process around build-outs can involve extensive negotiations between the building owner and tenant. Areas for discussion include:
- What improvements will be made?
- What materials will be used?
- Who will pay for the improvements?
- Who gets the work done?
- What improvements will remain after the lease ends? Will the tenant be required to remove all improvements that are made?
It is common for tenants to contribute to the build-out budget. Yet the average cost per square foot of build-outs using standard finishes reaches more than $65. So all parties must understand expectations and what to request during build-out negotiations. These days, tenants seek to update their spaces every few years. As a result, it is critical for landlords to understand commercial office build-out costs and negotiations.
- Commercial Construction Cost Breakdown
- Construction Costs for Corporate Interior Build-Outs
- BASIC OFFICE SPACE: $51 to $61/Square Foot
- MID-RANGE OFFICE SPACE: $65 to $80/Square Foot
- EXECUTIVE OFFICE SPACE: $96 to $157/Square Foot
- FURNITURE: $28 to $80/Square Foot ($20 to $70/square foot in 2018)
- FITNESS FACILITY: $155 to $210/Square Foot
- CONFERENCE CENTER: $150 to $205/Square Foot
- EMPLOYEE DINING FACILITY, KITCHEN, AND SERVERY: $162 to $241/SF
- Understand Build-Outs Costs for Attracting Tenants
- Hard Costs vs Soft Costs
- Retail Build-Out Costs
- Types of Commercial Office Build-Outs
- Tenant Improvement Costs and Concessions
- Determining the Amount of a TI Allowance for Build-Outs
- Office Type Also Influences Commercial Office Build-Out Costs
- Other Factors That Impact Build-Out Cost
- Demand for Creative Spaces Drives Tenant Improvements
- What Color Is Your Build-Out?
- Coworking Trend Adds to Increase in TI Costs
- Don’t Forget the Time Factor
- Final Thoughts
- Office Build-Out FAQs
Commercial Construction Cost Breakdown
As always, location is a key factor in determining costs. The Northeast and East Coast have always been expensive areas for commercial construction. Many of the most affordable real estate markets for commercial building construction are in the South, including Houston. This is due to more affordable costs for labor and materials.
The 2017 U.S. and Canada Fit Out Guide ranked Houston as the second most-affordable market for build-outs in. Currently, Houston continues to remain affordable.
According to Kirksey Architecture’s 19th annual Construction Cost Update survey of build-out costs in Houston, local costs are expected to rise. The three to five percent increase is due to labor shortages and the uncertainty of tariff implications on the pricing of construction materials. Specifically, the report says,
With the current and projected construction projects in the pipeline, lack of specialized labor remains a concern. It also applies upward pressure to construction costs. Since tariff activity remains unpredictable, there’s pricing uncertainty for some materials. As a result, producers most continue working through the potential impacts.
Here is Kirksey’s 2019 Cost Breakdown for finishing the interiors of office buildings in Houston. It expresses costs as the average cost per square foot of rentable area.
Construction Costs for Corporate Interior Build-Outs
(For a 25,000 gross square foot floor plate with 50 percent offices and 50 percent open plan; does not include owner-provided AV and IT equipment)
The quality of interior finishes also is a big factor that drives the cost of a project. High-quality or exotic woods, stone countertops, high-end doors, and other upscale finishes can provide an indicator of the tenant’s reputation for clients. Also, these may be necessary to be competitive in attracting the type of tenants desired by a commercial building owner. Kirksey Architects notes that the cost of finishing corporate interiors continues to go up as well:
Overall, the market is seeing a large jump in basic and mid-range build-outs and amenities. What’s more there’s a “flight to quality” for the top-end executive spaces. Without a doubt, it remains a tenant’s market. Especially with former Class A properties enticing tenants with better deals and new lobby and/or amenity upgrades.
BASIC OFFICE SPACE: $51 to $61/Square Foot
($43 to $54/square foot in 2018)
The most basic applicable space with landlord standards, but using all new components: basic 2×4 LED lighting, standard 2×2 ceiling, plastic laminate building standard doors with mortised hardware, 18” sidelight at office fronts, minimal millwork and all plastic laminate, $28/yard carpet tile, standard electrical and HVAC. Add up to $10/square foot for first-generation space.
MID-RANGE OFFICE SPACE: $65 to $80/Square Foot
($57 to $75/square foot in 2018)
Upgraded with linear LED lighting, 2×2 fineline ceiling, wood veneer building standard doors with mortised hardware, full-height glass office fronts in aluminum framing system, more extensive plastic laminate millwork with solid surface countertops throughout, $35/yard carpet tiles, more extensive electrical service with 24/7 server room AC and two supplemental fan-coil units for conference room zones. Add up to $10/square foot for first-generation space.
EXECUTIVE OFFICE SPACE: $96 to $157/Square Foot
($96 to $151/square foot in 2018)
Upgraded interior with indirect cove lighting in some ceilings and architectural grade wood doors and frames. Includes 40 percent of wall space covered in acoustical fabric; 30 percent of walls with premium architectural woodwork, and 30 percent as painted drywall. Also includes wood veneer millwork and granite countertops, and carpet and tile at $45/square yard. Other interior features include more extensive lighting and custom fixtures for artwork and accent areas. Add up to $10/square foot for first-generation space.
FURNITURE: $28 to $80/Square Foot ($20 to $70/square foot in 2018)
Basic office space: $28 to $30/square foot
Mid-range office space: $30 to $40/square foot
Executive office space: $40 to $80/square foot
FITNESS FACILITY: $155 to $210/Square Foot
($140 to $189/square foot in 2018)
Applies to a 10,000 square foot space with rubber flooring, frameless glass entry doors, and extensive wiring for electronics and audio. Includes men’s and women’s locker rooms with ceramic tile wet areas (four showers and two toilets each), and carpeted dressing areas with plastic laminate lockers.
CONFERENCE CENTER: $150 to $205/Square Foot
($136 to $198/square foot in 2018)
Similar to executive office space, except with ceiling system and acoustical upgrades, as well as individual fan-coil units for each room, VIP lounge area with millwork, coffee service, and receptionist millwork.
EMPLOYEE DINING FACILITY, KITCHEN, AND SERVERY: $162 to $241/SF
($157 to $208/square foot in 2018)
For a 5,000 square foot kitchen area with tile flooring and painted drywall; custom millwork at a food service area and grab-and-go station; ceramic tile throughout; dining area with a mix of drywall and acoustical ceilings, linear LED lighting, indirect cove and pendant accent lighting; and some low walls with wood paneling as room dividers.
Understand Build-Outs Costs for Attracting Tenants
There is a wide range of building sizes, types and potential uses. Faced with such variety, commercial building owners must understand the costs surrounding commercial office space improvements. Having this knowledge will help owners attract successful tenants who contribute predictable rental income.
Commercial construction costs for office build-outs also can vary by season. Specifically, fuel, transport, and material costs can be affected by weather. Of course, the availability of labor also can be affected by seasonal fluctuations.
Our experts at CXRE can help owners develop negotiating strategies. We can help determine who pays for the hard costs and soft costs associated with the lease of a commercial property.
Hard Costs vs Soft Costs
Hard costs are improvements that will remain after the tenant leaves. Typically, these costs apply to physical changes to the property that can benefit the landlord. They include:
- doors and windows and associated hardware
- paint and carpet
- millwork and moldings
- HVAC systems, fire alarms, and sprinklers
- drywall, framing, acoustical ceilings and walls
- electrical, mechanical and plumbing systems
Hard costs also cover the labor involved in construction. Hard costs can vary tremendously, depending on the extent of the renovation and the quality of materials and finishes the tenant chooses. But they typically account for 75 to 85 percent of the cost of a commercial build-out.
Soft costs do not include physical changes to the commercial space. Soft costs typically account for 8 to 12 percent of the total project cost. On top of that, soft costs generally are easier to estimate than hard costs. The term typically refers to the expenses and fees for services needed to complete the project to meet the needs of a specific tenant. These expenses can include:
- building permits
- legal fees
- architectural plans
Other build-out expenses include vendor costs. These costs, which can include signage, security, telephone, and computer cabling, and moving costs, typically can account for 5 to10 percent of a tenant’s budget.
Retail Build-Out Costs
The amount of retail build-out costs vary depending on whether the space is in a major metropolitan area, or an older building in a smaller town.
For office buildings that include retail space, the 2019 edition of Chain Store Age’s annual survey of retail build-outs put the average retail build-out cost at $56.53 per square foot.
In a retail build-out, flooring on average takes up $2.76 per square foot in a budget and ceilings take $1.81, according to Chain Store Age. The cost of either fixing, replacing or installing an HVAC system costs on average about $2.61 per square foot, or about $13,000 for a 5,000-square-foot space.
The typical cost of installing interior lighting is about $3.30 per square foot, according to Chain Store Age.
On average, retail build-outs spend almost $10 a square foot on display fixtures or millwork, according to the Chain Store Age survey. That’s roughly 20 percent of an average budget.
Depending on the business and type of space needed, a tenant may choose to use an office design team to manage the build-out of a commercial space. Such a team may include an architect, interior designer, space planner, and general contractor to help set a budget and completion timeline based on planned usage, desired fits and finishes, and the tenant’s future growth plans. Hiring a designer or architect could take up to 20 percent of the build-out budget.
Types of Commercial Office Build-Outs
As to be expected, a larger commercial office build-out project will be more expensive, because more material will be required, and labor costs for the construction effort will be higher. Owners may enjoy some economies of scale with larger projects due to the ability of contractors to secure lower per unit material costs and the ability to obtain discounts for ordering supplies in bulk. So large projects usually will have a lower price per square foot compared to smaller projects.
However, looking at construction costs alone will not give the full picture of the costs of moving a new tenant into office space. The lease rate, tenant allowances and landlord concessions (like free rent periods) all combine to determine the renter’s ultimate cost.
Landlords typically can choose from among four ways to pay for the modifications needed to make a commercial space suitable for renter’s business needs. They include rent discounts; building standard allowance; turnkey office build-out; and tenant improvement allowance. We’ll provide a quick overview of each method, along with more extensive discussion of the two most-common options – the turnkey and tenant improvement build-out.
The landlord will offer free or discounted rent for a certain number of months. The tenant then can use the savings to pay for improvements. The tenant usually oversees the work. A typical option might be one month of free rent for each year of the lease.
Building Standard Allowance
The landlord offers a specific package of improvements available to all tenants. Tenants can select options from the categories offered, like choices on a menu. For example, a tenant could choose from two or three specific types of flooring, or certain paint colors. The tenant pays for any improvements not included in the standard allowance, and the landlord oversees the work.
Turnkey Office Build-out
The other primary option in build-outs is a turnkey office build-out – meaning all the tenant has to do is turn the key in the front door and everything they need to start conducting business already is in place. In this instance, the landlord is responsible for paying for all of the improvements, leaving only minor costs, like furniture, for the tenant. The details of the customization are mutually agreed upon when the lease is negotiated.
The key to ensuring a good outcome for both the landlord and tenant is developing plans that clearly identify what will be built and delivered to the tenant. This process requires detailed plans, good communication between all parties involved in the negotiation and design process, and strong oversight of the general contractor by the landlord.
If a turnkey build-out is negotiated, the tenant must provide specific plans, cost estimates, and required timelines. A turnkey arrangement may give the landlord some control over the final finish of the space. But the tenant should be specific about the quality of work and materials they desire. The tenant’s negotiation also should take into consideration how the cost of a landlord-provided build-out will be reflected in their lease rate.
Building owners should examine the tenant’s preliminary pricing plan to ensure that the projected construction and installation costs are acceptable. The pricing plan also will show specific items such as walls, doors, millwork, and electrical outlets, and provide details about finishes, as well as notes on the plumbing required for break rooms or coffee bars. The plan also can cover other miscellaneous notes required for the proposed construction.
If the landlord approves the pricing plan, it is then shared with at least three general contractors experienced with office build-out construction to obtain preliminary pricing for the proposed project.
Once the landlord accepts the preliminary construction pricing, the build-out moves forward. However, if the landlord thinks the proposed costs are too high, the parties can engage in additional negotiations. At this point, the tenant may continue to negotiate or walk away from the deal. If an agreement is reached, the owner will authorize moving to the step of creating detailed construction drawings.
Turnkey build-outs are a good option for leasing less than 10,000 square feet of space. The turnkey option also is beneficial for tenants with short-term leases, since they have no leverage to negotiate for a larger tenant improvement allowance.
Tenant Improvement (TI) Build-Out
Offering a tenant improvement (TI) allowance is the most common way that landlords pay for commercial improvements. Landlords often offer tenants a payment or a discount on rent to help tenants make necessary improvements to a leased commercial space before it is suitable for a business. For example, an office space may need communal, open-plan workspaces and conference rooms for employees, or a restaurant might need kitchen space for food preparation and customer seating areas. The tenant usually oversees the work in a TI build-out and is responsible for any improvements that exceed the cost of the allowance.
Landlords may place restrictions on what items the tenant allowance will pay for, such as only for labor, construction, and materials. For example, tenant improvement allowances typically do not include the costs of furniture, fixtures, and equipment, or trade fixtures needed for the tenant to conduct business. Tenants may negotiate to have the allowance cover other costs, such as space planning, office design or legal fees.
For anything other than very minor construction, a tenant improvement work letter addendum or attachment should be made part of the lease document. A well-drafted work letter will spell out all key issues related to the construction of the planned tenant improvements and will limit costly change orders during the build-out. It will define the building’s standards and break down construction details such as the number of light fixtures, size of doors and all other interior elements that the landlord will install for the tenant.
The work letter specifies the project budget, and lays out how the tenant will pay for any additional costs over the allowance amount. It also describes any warranty coverage provided by the landlord or general contractor. Typically, the lease is signed before the landlord and tenant reach agreement on all items in the work letter.
Tenant Improvement Costs and Concessions
In general, tenant improvement costs are growing faster than rents in all markets in the US. Tenant improvement allowances have increased by double digits in recent years, growing more than 10 percent in 2017, and 13 percent in 2018, according to the 2019 U.S. and Canada Fit Out Guide.
However, research shows that while tenant improvement concessions in most markets were likely to be higher for all of 2019, generous tenant improvement allowances haven’t kept up with construction cost growth.
The average cost of an office build-out increased 12 percent in 2018. Also, about 60 percent of construction cost increases were offset by increases in TI allowances. But that means 40 percent of construction cost increases were passed on to tenants. So the investors’ time frame for absorbing tenant improvement allowances has to be spread over a longer period.
The good news is that an improved building will attract new leases and owners will be able to charge higher rental rates. The improved building also will be more appealing to lenders and could lead to more favorable mortgage terms.
Of course, the amount of the tenant improvement allowance, and the cost of improvements, can vary depending on location. Most landlords provide tenant improvement packages to help renters cover some of the costs of building out a space. That is especially true in today’s market, since more tenants now want an office that’s tailored to their needs. Landlords usually will offer a tenant improvement package that covers a small portion of the construction costs, but in some cities, tenants receive enough to offset their bill considerably.
According to Structen Group, an interior architecture and planning firm, the average landlord provided tenant improvement cost was $43 per square foot, bringing the nationwide average total build-out cost to $196 per square foot. The firm found that Washington, DC was the most affordable market for tenant build-out at $103 per square foot, due to generous tenant improvement allowances.
Structen Group’s average design, build-out and furniture cost in Washington, DC was an average of $85 per square foot for design, construction and furniture, plus an additional $20-30 per square for IT, audiovisual and moving-related costs.
The firm found that the average cost for design, construction, furniture and moving costs in Washington, DC is around $150 per square foot. However, large tenant improvement allowances of around $50 per square foot make the tenant’s out of pockets cost lower.
Determining the Amount of a TI Allowance for Build-Outs
Providing a tenant improvement allowance represents a risk for the landlord. The owner wants to be sure a prospective tenant can pay back the allowance and pay the rent for the duration of the lease. The amount of a tenant improvement allowance is usually determined by four factors:
- The creditworthiness of the tenant: determined by credit rating, time in business and the long-term prospects of the business.
- Supply and demand in the local commercial real estate market: landlords often keep their net rental rates stable, and increase or decrease incentives like tenant improvement allowances to account for changes in market conditions.
- The condition of the commercial space: landlords whose buildings are below the market standard will be forced to provide an above-market tenant improvement allowance to compensate.
- The size of the landlord: larger commercial property owners usually will provide larger tenant improvement allowances, since they will have deeper pockets and a greater risk tolerance.
Office Type Also Influences Commercial Office Build-Out Costs
Tenant improvement build-out costs also are impacted by the type of building that is being leased.
First Generation (also known as a shell): A space that has never been occupied before, probably with only a concrete floor. Tenant improvement build-outs to these spaces also are known as capital improvement projects. Usually, these involve major alterations to the look and infrastructure of office space. These projects generally require a larger budget than improving existing space.
Second Generation: A space that has been previously occupied and built out. It may contain improvements that an incoming tenant can reuse or repurpose. Improvements to second-gen spaces, also known as renovations, include minor projects that are mostly visual. Frequently, these require a low amount of work and expenses, such as new paint and carpet.
Building class also drives build-out costs. Here are the industry classifications for office space in individual markets, according to the Building Owners and Managers Association International.
Class A: The most prestigious buildings competing for premier office users with rents above average for the area. Buildings have high-quality standard finishes, state of the art systems, exceptional accessibility and a definite market presence.
Class B: Buildings competing for a wide range of users with rents in the average range for the area. Building finishes are fair to good for the area. Building finishes are fair to good for the area and systems are adequate, but the building does not compete with Class A at the same price.
Class C: Buildings competing for tenants requiring functional space at rents below the average for the area.
As a result, there is not a simple one-size-fits-all answer to how much a commercial office build-out will cost, because costs vary widely depending on the market.
Progressive office space, considered to be the leading-edge office space, has an open floor plan with no enclosed offices, 100 percent of desk space outfitted as bench-style furniture, but plenty of conference and collaboration. On average, the cost per square foot to build out progressive office space ranges from $147 to $167, due to minimal dividing walls. But this space type has higher technology costs due to tech requirements for the many multiuse, collaborative spaces and common areas.
Moderate office space has 10 percent of the area allotted to private offices; the remaining space may be open with workstations, along with some conference rooms and several collaboration or multi-use spaces. It is the most common office design, with 52 percent of corporate tenants reporting using this type of space. It provides a blend of the benefits of open and private office spaces. The average cost to build out a moderate office style is $170 to $196 per square foot.
Traditional: About 21 percent of offices today are in this category, usually for tenants for whom employee or customer privacy is important. They have about 30 percent of space devoted to individual offices, with the remainder of space devoted to an open floor plan, relatively large eight-foot spaces, and conference rooms. Collaboration space is minimal. The average cost to build these spaces is $193 to $224 per square foot, according to JLL.
Employee density for progressive spaces is considerably higher – 20 to 50 percent – than the two other styles. Average build-out costs, on the other hand, are lower at $152.23 per square foot versus $158.23 for moderate space and $177.06 for traditional.
Progressive spaces, sometimes known as creative spaces, offer attractions beyond the floor layout. These spaces include tenant-focused features such as workout or recreation areas; coffee bars, and outdoor or rooftop spaces for tenants.
New buildings in shell condition will be more expensive to finish than second-generation buildings. The quality of finishes – usually categorized as standard, midpoint, or high end/high finish – can add to the price, as does the cost of labor.
Bear in mind that specialized commercial spaces like legal or medical offices will be more costly to build out than basic office or retail locations.
Other Factors That Impact Build-Out Cost
The business of the tenant ultimately is the main determinant of the commercial construction cost breakdown for a retail or office space. A tenant whose business requires a lot of customer interaction in its space, like a medical office, law firm, or retail establishment, often will invest heavily in the quality of finishes in common areas, conference rooms or individual offices. By contrast, a tenant whose business is based on fulfilling customer orders over the phone may not see the need to invest in much more than four walls, desks and carpet tiles. Below are other cost factors to consider in commercial office build-outs:
The condition of the space
Shell space requires major capital improvements, but offers a blank slate for tenant improvement build-outs, usually
at a much higher average cost per square foot.
Second-generation space usually requires only minor renovations, focusing on improving aesthetic or visual elements like paint and carpet, or small changes like updates to electrical, computer cabling, or plumbing systems. Building out second-generation space requires a smaller budget than shell space.
The size of the space
The larger the project, the more expensive it will be, in terms of total costs for materials and labor. But owners and tenants can benefit from economies of scale, so their costs on a per-square-foot basis may be lower than for larger projects.
Quality of the finishes
As noted, adding higher quality finishes or specialized equipment will cost more.
Demand for Creative Spaces Drives Tenant Improvements
Today’s office tenants want customizable, creative spaces that give them the flexibility to adjust their space as their business grows. Creative space can be hard to define, and often is described in terms of the tenants who occupy it. These tenants commonly are described as TAMI tenants – those who work in the areas of Technology, Advertising, Media and Information.
Today’s employees demand innovative interiors that can include elements such as game rooms, living plant walls, in-house bars, workout spaces, and accessible outdoor areas. Features like exposed brick walls, architectural wood beams, exposed interior structural columns, and open ceilings can help building owners justify higher rents – either for non-traditional but trendy locations, or for “cool” interior features.
The spaces also offer more use of residential design elements like oversized upholstered seating, colorful indirect lighting, and occasional tables to create cozy, comfortable spaces for collaboration. It becomes a critical selling point for employers, because studies show that employees aged 20-24 may stay at a firm only for about 16 months. These “softer” office environments actually can reduce employee stress and increase productivity, leading to greater job satisfaction and employee retention.
The good news is these open spaces can be constructed more quickly and less expensively than traditional office space, due to the elimination of hard walls, suspended ceilings, and the desire for more employee interaction. Investors often can bring in new tenants with reduced tenant improvement costs.
This shift from traditional office spaces has gained momentum and broad acceptance over the last 20 years. Formerly only the purview of small or start-up technology or software firms, these innovative office features now are widely accepted and desired by a wide range of office tenants, including those operating in more traditional businesses. As this type of space has gained broad acceptance, the risk of investing in these creative office spaces for commercial building investors has lessened considerably.
What Color Is Your Build-Out?
To further complicate owners’ choices, construction contractors often speak about commercial office space buildouts in terms of the “color” of the shell being provided to tenants.
Gray Shell Office Build-Outs
In a gray (or dark) shell tenant improvement, the space is typically an open box (shell) with virtually no improvements inside. Dark shells usually have no ceiling grid, no drywall on the exterior walls and no stub-outs for utilities or systems. In other words, there are no improvements to the space whatsoever.
In this scenario, the tenant is responsible for every aspect of the build-out. The time and cost required for gray shell commercial office build-outs can be substantial.
Vanilla Shell Office Build-Outs
The term vanilla shell typically refers to a tenant space that has a ceiling grid and drywall in place. This type of space also should have basic plumbing and electrical systems installed, and have stub-outs for heating, ventilation and cooling. A vanilla shell may even have restrooms installed along with the basics of a heating and cooling system. The time to complete this type of build-out is also much shorter in most cases.
An Emerging Cost for Owners – “Whiteboxing”
An emerging hidden cost for owners in certain competitive markets is the growing trend known as “whiteboxing.” This practice removes all traces of the previous tenant from a second-generation office space. The owner then strips the space back to a raw, shell-like state with no interior walls, wall coverings, paint, or finished flooring.
A whitebox renovation only would include a basic finished ceiling, concrete floor, basic heating, ventilation and air conditioning (HVAC), basic electrical and plumbing, and other features required by local building codes.
The idea is to create a shell that allows the tenants to see themselves in the space. Whiteboxing allows a commercial property owner to quickly incorporate a new client into their property but can cost an owner tens of thousands of dollars before a client even signs a lease.
Remember that if you have to take on a whiteboxing project, it also may be a good time to examine and replace any HVAC, plumbing, mechanical, electrical or other building systems that may be nearing the end of their expected useful life, while the walls of the building are open.
Coworking Trend Adds to Increase in TI Costs
Coworking space has led all other office user types in absorption so far this year, accounting for more than 5.4 million square feet between January and June.
Another emerging cost is the rise of open, coworking spaces. The rapid growth of the coworking movement has created a demand among all office tenants for modern office spaces with cutting-edge amenities and technological infrastructure. Even startup firms want “cool,” amenity-rich workspaces!
As a result, commercial building owners have had to invest heavily in feature-rich spaces or make expensive renovations of trendy older buildings in urban centers. For example, creating spaces with open ceilings and exposed pipes and ductwork actually can be very expensive, as it requires the building owner to spend heavily to make the exposed mechanical and plumbing elements look clean and meet local building codes.
This has added to the rising tenant improvement allowance, as larger, more valuable tenants use their status to exert leverage clout in negotiations with landlords.
Don’t Forget the Time Factor
One element that owners often can overlook is the timeline. It’s essential for owners to have a realistic understanding of the time needed to complete an office build-out. If the tenant manages the renovation, it might take significantly more time to engage a designer, architect, or space planner. Also, it might take longer to find contractors and gather needed construction materials.
An owner must ensure that tenants have a realistic preliminary project schedule. Also, the owner should schedule regular check-ins. These will ensure that project milestones are met and the build-out timeline for completion remains on track. In addition, it helps to understand the process of commercial office build-outs from a tenant’s perspective.
The growing percentage of millennials in the workforce has led to strong demand for collaborative workspaces that promote creative thinking. Millennials seek unique office space design, supporting collaborative work that promotes creative thinking. And these employees are strongly influenced by innovative workspaces of prospective employers.
Today, the majority of tenants want to update their office space every year or two. The reason? Current business strategies emphasize ongoing, timely releases along with and constant development. Overall, both tenants and employees now expect the evolution of their workspaces.
Employees face an evolving business environment that requires them to be “always on.” So they demand office spaces that support their need to spend so much of their time in the office. That requires premium spaces with features such as open collaborative spaces; personal, concierge-like services; and robust technological infrastructure.
Businesses that lack these new “tenant-centric” features and finishes. As a result, they may find it more difficult to attract and retain the best, most creative talent. So commercial office building owners must prepare for the challenges and high cost of designing and managing these amenity-rich spaces.
Commercial property owners should manage commercial office build-outs to give tenants the ability to change. Specifically, tenants should be allowed to upgrade their space over the years. In general, owners need to meet the needs of tenants who use their office space as an employee recruiting and retention tool.
A primary goal for tenants is the ability to make significant alterations every few years within an existing space, rather than needing to relocate entirely. So, landlords must build with flexibility in mind to meet tenants’ desire for more frequently updated office space and to achieve expected returns on build-outs. “This adaptability can come in many forms,” according to the group’s the 2019 Fit Out guide. “From layouts that require limited modifications to increase density, to rooms that are easily converted as space needs change.”
Investors are flocking to markets with good fundamentals, rising population and job growth, and a well-educated, highly trained workforce. But many office investors view the rising cost of tenant improvements as a challenge. It’s important for commercial office building owners to understand the cost drivers for any commercial project. In addition, owners must know how variables (building type, construction type, and location) drive costs in their market.
Commercial property owners should take this new environment into account when making office build-out negotiations and decisions. What’s more, owners should engage with contractors with the ability to find economies of scale that streamline the build-out process.
CXRE is the building owner’s trusted brokerage, property and leasing team. We have over 21 years of experience advising commercial real estate investors. And we’ve represented more than five million square feet of commercial real estate for investors.
Making commercial property improvements is a normal part of the property ownership life cycle. Owners must upgrade systems, fixtures and interior elements in order to attract high-quality tenants. Owners can help control these costs through good planning and management. The service-focused team at CXRE is ready to help.
Without a doubt, commercial office build-outs of tenant spaces come with complications. As such, a lot of negotiation happens. If you are ready to begin, your CXRE representative/broker can help. We’ll help you formulate a negotiation strategy for tenant improvements for your office build-out. We are passionate about service and have helped (hundreds?) of clients create budgets for commercial office space build-out projects.
Tenants desire a sense of ownership, peace, and energy in their workplaces. At CXRE, this energy flows from very fast tenant responses, lovely common areas, well-planned gathering spaces, and movement throughout the building. Ideally, we want tenants to interact with each other in restaurants, social media, and elevator lobbies. These interactions slowly become commonplace and give the tenant a sense of belonging. We all want to belong.
Our CXRE team members are passionate about service. As a building owner, your most important clients are your tenants. So it makes sense that your tenants are our most important clients as well.
Office Build-Out FAQs
- Q: Does the landlord oversee contractors in a tenant improvement allowance?
A: Under a tenant improvement (TI) allowance, the tenant oversees the contractors. After negotiating upfront with the landlord, the tenant makes the improvements . This negotiation determines the cost per square foot the landlord will contribute to pay for improvements and customization. With a tenant improvement build-out, the tenant is in control. Basically, the tenant selects the architect, hires the best contractors, and purchases quality finishes, while carefully watching the budget.
- Q: What factors affect the amount of the tenant improvement allowance?
A: Generally, with a longer lease term, or a larger amount of leased space, the tenant can negotiate a higher tenant improvement allowance.
- Q: Does a tenant improvement allowance have to be repaid?
A: A tenant improvement allowance typically does not have to be repaid. As a result, it can be a major inducement for a tenant signing a lease. But a tenant improvement build-out process also requires clarity. All parties be extremely clear on what the allowance does and does not include.
- Q: Does the tenant improvement allowance cover all costs of my move-in?
A: The tenant improvement allowance rarely covers everything a tenant needs to finish the space and open for business. The landlord often only is concerned with improvements that will increase the value of the property. Typically, TI allowances exclude items like furniture, data and telephone cabling, decorations, and artwork.
- Q: How do you calculate the TI allowance budget?
A: The lease negotiations determine the tenant improvement budget. Both parties agree on a dollar amount per square foot that the landlord will allow and that the tenant is will accept. It is important for tenants to enter negotiations with an accurate cost projection for their desired improvements.
- Q: Does the landlord charge interest in funding the tenant improvement allowance?
A: Yes, the landlord typically charges the tenant interest. This interest covers the risk that the tenant won’t repay the allowance due to lease defaults, bad debts, or bankruptcy.
- Q: Can a tenant keep any unused tenant improvement allowance?
A: It depends. Some lease arrangements allow the tenant to keep the unused portion of the allowance. Tenants can then apply it to rent or for future improvements. But other lease arrangements allow the landlord to recover unused portions of the allowance.
- Q: Does the landlord pay the TI allowance upfront to the tenant?
A: Tenant allowances typically are reimbursements. So tenants need to cover the cost of the build-out. They then submit receipts to the landlord for reimbursement after the office space is fully (or substantially) complete.
- Q: Will the landlord negotiate to pay the TI allowance as cash upfront to the tenant?
A: If cash flow is an issue, then a landlord may negotiate with a potential tenant. In this case, the landlord converts the TI allowance to a cash allowance, paid upon execution of the lease.
- Q: Does the tenant need the landlord’s approval to make improvements?
A: Yes! The landlord wants to know that any changes will increase the commercial office space’s economic value. And it will make it more attractive to future tenants.
- Q: What if the tenant has a weak credit rating? Are there other factors that could persuade a landlord to provide a larger tenant improvement allowance?
A: Maybe. But the prospective tenant will likely need to provide more security to the landlord. This might be a combination of a larger deposit, a security deposit, or a letter of credit. It could also be giving up free rent or agreeing to a higher rental rate.