Tenant Improvements, also called Leasehold Improvements is an area of tenant and property owner relations that many people don’t fully understand before they begin lease negotiations. According to the Certified Commercial Investing Member Institute the definition of Tenant Improvements is: “the customized alterations a building owner makes to rental space as part of a lease agreement, in order to configure the space for the needs of that particular tenant. These include changes to walls, floors, ceilings, and lighting, among others.”
The important take away from the definition is that these are alterations made to configure the space for the tenants needs. The purpose is to suit the space to make it the best fit for an individual tenant. There are several considerations from both the property owner and the tenants perspective that should be taken into account when negotiating a lease involving tenant improvements.
Tenant Improvement Negotiation and Construction
We’ll start with an overview of the TI (Tenant Improvement) negotiation process and then work our way through the construction project overview.
A great outline of items to look for when discussing and negotiating a TI deal can be found in the article The Five Things You Need To Know About Tenant Improvement Allowances. They discuss the following topics:
- The Turn-Key Build Out – Its a great situation for tenants, but its becoming more difficult to find as economic situations improve and there is increasing demand for space.
- Rentable vs. Usable – This discusses the per square foot allowance tenants may be given for improvements and how that relates to rentable space, including common area, and usable space.
- Whats Included – Does the TI allowance include materials, repainting walls, doors, HVAC, architectural, permits, project management, etc.? How is the allowance disbursed? Some TI’s may include furnishings. Its also possible that some of the allowance may be used at a later point in the lease if not used immediately.
- Substantial Completion – Its important to make sure that timing of the completion and usability of the rental space coincide with the beginning of rental payments by the tenant. Many factors may influence this timeline including permitting, architecture, construction, etc.
- Additional Costs – There may be cost overruns on the improvements. Its important to have a mutually agreed upon approach and plan in place for this contingency. Is there a buildout allowance cap? Are there associated project management fees, etc.?
Once you have discussed and negotiated the tenant improvements its time to begin the construction planning and management of the project.
Depending on the size and scope of the improvements you will need to begin with design, planning, and construction cost estimation. Its important to ensure you have an experienced, licensed team familiar with the building codes and regulations for the area where you will have the work done in order to ensure that you meet the municipalities requirements for design and permitting.
An experienced architect will help manage the design and planning aspects and can guide you through the process of satisfying all building codes and ADA requirements. If you do not yet have an architect and you are working on a project in the Southern California area we can refer you to an architect with appropriate experience for your area and requirements.
The next step is construction cost estimating and contractor selection. When you begin the process of finding a commercial construction contractor to complete your tenant improvements there are some specific items you should be looking or asking for:
- Is the contractor licensed?
- Are they insured?
- Can they give you references?
- Examples of similar tenant improvement projects they have completed in the past?
- How long have they been in business?
Andersen Construction can provide you with a preliminary cost estimate based on your specifications. However, it is important to realize that until projects are ready to submit to the city for final approval and everything has been itemized and aligned with the final plans and specifications it is not possible to give a completely accurate final cost estimate. Changes to the plans that occur before they are submitted often cause the cost estimates for projects to vary. Always ask for and expect a detailed cost estimate once you reach this stage. Additionally, its important to include an allowance for any areas that might remain unclear to cover any contingencies.
Construction In Progress
Construction progress should evaluated on a regular basis. Often architects or construction management companies will do this for a fee. However it is handled you should ask to receive weekly reports and someone should verify that these are meeting the milestones set in the original project schedule. These reports should also include building department inspection results, pictures of progress made and any updates to the schedule.
- Weekly Reports Including:
- Building Department Inspection Reports
- Pictures of Progress Made
- Schedule Updates
- Notifications of Potentials for Delay
- Utilities – Ensure that all are set up and ready for construction approval to avoid delays.
Payments to contractors may vary depending on the project requirement. Generally construction contractors are paid when work is completed and billed monthly. There are exceptions to this depending on the projects requirements. The most important thing is to make sure these terms are clear and agreed upon upfront so there is no misunderstanding.
Certificate of Occupancy
Once the project is completed you should obtain a certificate of occupancy. This shows that the work has been inspected and approved by all the relevant local authorities. Now the space is ready for you to use for your business.
Final Walk Through and Punch List
“In the United States construction industry, contract agreements are usually written to allow the owner to withhold (retain) the final payment to the general contractor as “retainage”. The contractor is bound by the contract to complete a list of contract items, called a punch list, in order to receive final payment from the owner. The designer (typically a licensed Professional Architect or Engineer), is usually also incorporated into the contract as the owner’s design representative and agent, to verify that completed contract work has complied with the design.”
Once all the construction processes have been completed there should be a final walk through with the contractor. Each item on the punch list should have been marked off as construction work was completed. However, it is not uncommon for there to still be some items remaining on the list. The final walk through will allow everyone involved to verify that all the items on the punch list have been completed and that any minor items are finished, or corrected as necessary.
Make sure that you keep copies of all the drawings, designs, contracts, and other documents involved in your tenant improvement construction project. These will often be a starting point for any changes, fixes, or alterations you may need in the future.
Andersen Construction has been providing commercial construction services for more than 30 years throughout the Southern California area. We have worked on tenant improvement construction projects in Long Beach, Gardena, Compton, and throughout Los Angeles County and Orange County.