Three common mistakes to avoid during tenant improvement
According to the CCIM Institute, tenant improvements, or leasehold improvements, are 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.
Tenant improvements (TI), fit out, build out, etc. are just different ways to describe interior renovations that a company needs for their work space. Whether the organization works in the retail, office, industrial, medical sectors, etc., the process is typically the same.
For this article we will focus on office, but the principles and ideas here can easily be translated to other asset types and industries.
According to Bloomberg, TI’s soared 12% last year. If you look at “market research” from some of real estate’s major players in the US, the national average for TI has hovered around $30 per square foot (sf) since about 2010. Major central business districts have generally seen TI costs around $50 per sf. (Of course with any rule, there are exceptions.)
In major markets like Manhattan, older office buildings must compete with the supply of newer, high-end buildings. As a result, TI average costs are closer to $75 per sf.
The question remains, are these just “hard costs” or do they include “soft costs?” Honestly, we don’t know how the data was collected or reported. Based on our experience, these reported costs are worthy targets when building on office spaces.
The Associated General Contractors of America (AGC) defines hard costs as costs paid under a construction contract for tangible items, including fees and general conditions. Think of these costs as materials, labor, and contractor fees.
Soft costs typically include less tangible items such as design and financing costs, and other taxes or fees. Environmental testing, architectural or interior design services, engineering design, construction management are just a few examples of soft costs. When budgeting your project, be sure to incorporate soft costs!
Usually there are several consistent key players involved in a TI.
Let’s split everyone up into two teams, Landlord and Tenant.
Landlord Team:
- Broker/ Leasing Agent
- Property Manager
- Construction Manager
- Building Engineer (Maintenance Supervisor)
- Asset Manager
Tenant Team:
- Broker/ Leasing Agent
- Tenant Lead
Free Agents (either Team):
- Architect(s)/ Space Planner(s)
- Engineer(s)
- Contractor(s)
- Construction Manager(s)
- Consultant(s) – acoustics, ADA, interior design, building envelope, roofing, etc.
In our experience, coordinating with several of these “team” members to build out a new tenant space can be challenging. Each individual and organization plays by a different set of rules unique to their organization, with a level of talent and training that can vary greatly. And let’s be honest, some play better on teams than others.
We believe that unreasonable deadlines and the desire to close a “deal” quickly can leave the design/ construction team holding a ticking time bomb.
Common Mistakes
Working across international markets on various asset types with a multitude of brokers, asset managers, tenants, architects, and contractors, you see things.
Through our own experience, we have come up with a short list of challenges that make the process harder than it should be.
Unclear Scope
If I asked you to build a new office building, you would hopefully ask for construction drawings and specifications. In the TI world, rarely is such a luxury available during the planning and budgeting phase [read: during lease negotiations].
In order to sign a lease, most tenants and landlords need to know what the design and construction efforts will cost. However, at this point in the process, landlords and tenants do not want to invest the time and dollars to prepare well-defined design documents with a clear scope of work. They are most likely evaluating several key factors including rent rate, location, rent growth, etc.
We have seen several iterations of work letters that need to be priced or budgeted. This continually “revising” of the scope and updating the pricing will at times test the patience of good contractors and consultants. They are too busy doing work that they already have under contract to continually chase work that may or may not get approvals to proceed. It’s not magic, it’s math.
]”It is more important to know where you are going than to get there quickly. Do not mistake activity for achievement.”
-Isocrates
Speed is great. But speed without direction is just a quick way to get off course.
To avoid a communication breakdown, everyone from the tenant to the landlord to the design/ construction team need to clearly define the scope. It would be great to have clear deadlines for decisions, likelihood or probability of the lease being signed, or understanding what the priorities of the tenant are for building out their space.
Alas, we can dream.
Unreasonable Schedules
“Can the space be delivered in 2 weeks?”
In this case, the asset manager needed help to understand what was being communicated from the property and their broker.
I tried not to laugh, but any story that starts with, “But the broker said…,” will always have an interesting ending. In this case, a broker had been working this particular transaction and lease for months; now they wanted to rush the construction.
New paint, new carpet – sure, no problem – assuming lead times for material are short. But when you talk about permitting, ordering high-end finishes, coordinating with designers, signing contracts with multiple parties, good luck.
During any (good) bid process, you want to know how much things cost and how long they will take to complete. Ask for start dates, approximate lead times for materials, and time needed for mobilization of labor. Most importantly, write them down and add them up! Do they seem reasonable?
Depending on the market activity, construction labor, building materials, and even attention can all be in short supply. “Rush delivery” is possible, but just like overnight shipping it comes at a premium cost.
Promises are made in leases to deliver tenant spaces on dates that are just not humanly possible. It pays to talk with all team members to understand potential impacts to the schedule and the commencement date.
Sometimes, the longest delays can be from the landlord or tenant making material selections (or approving changes to finishes they already selected once).
Most government approvals take a long time. If a City permit and approval is required, buckle up; some reviews take two weeks, others can take up to eight. Some jurisdictions allow you to pay an expedited fee, others do not.
Either way, it pays to know what key decisions and approvals are required in the construction process. Contingencies should not simply be reserved for dollars within the budget. Build a contingency in the schedule as well.
Plan for things to go wrong. Anticipate delays.
Poorly Estimated Budgets
Imagine hiring a contractor to do work on your home only to realize that what you thought was a screaming deal, turned out to be a clumsy error that underestimated the true costs of construction.
Now imagine you hired a third party construction manager to help with bidding the work to your house, but this person was so busy on their current workload that they did not realize the contractor completely omitted new flooring from their estimate.
What if the address at the top of the contractor’s estimate was for another property all together? Are the prices correct but the address is not? Or are the prices incorrect too?
These stories are not as uncommon as you think in the world of commercial real estate. Underestimating is just as dangerous as overestimating.
You hear investment groups talk about their “cost of capital.” Contractors have three main components in their budgets. It’s really simple- material, labor, and overhead. Their costs in all three areas will determine your budget.
Maybe one contractor does not realize they are overpaying for electrical materials. Maybe another contractor has high-end offices with large marketing departments that increase their need for more overhead. Maybe they are overpaying for labor when it comes to painting.
Local market constraints can cause material or labor swings in price. Sometimes contractors could estimate their permitting fees instead of taking the time to call the City or Authority Having Jurisdiction. Having multiple data points (aka bids) can be useful in evaluating contractor pricing. Three is a good round number, but depending on the company policy and the market you may need more.
Under or overestimating is not limited to contractors. If you are paying for design services from architects, engineers, or other consultants, the same rules apply. We are not saying that you should expect perfection when it comes to preparing realistic budgets.
Contingencies are important, but they should have some basis in reality and past experiences. If you notice a contractor or designer’s estimate with several “allowances,” it’s okay to ask some qualifying questions such as, “Can you share a recent project with your budget and actual numbers?”
We are simply saying we have observed common mistakes that to us seemed to be more of a function of haste and, at times, carelessness. Performing a TI is not rocket science or brain surgery. There is a process that has been around for thousands of years.
Plan → Design → Build
What makes such a simple process challenging?
People. Environments. Budgets. Schedules.
Now What?
Execution is the name of the game. We want to help you elevate your game and win.
One way to do that is to have a consistent process. Think of how a scientist or researcher would run an experiment. They would establish a procedure and follow the steps in order to evaluate their performance.
Key questions for any type of process include:
- Can we replicate our results [which are hopefully good] with other team members?
- Can we eliminate any steps that are unnecessary?
- Are there other steps that we need to incorporate to allow us to execute the work faster, while maintaining quality?
We use a custom TI flowchart to help us to follow a baseline, standard procedure.
Another useful tool is our central “cheatsheet” that allows team members to effectively communicate. Having a TI Roster provides a quick reference for all the players on the project. “Who-is-in-charge-of-what” is taken care of with this centralized information.
Save your copy of the TI Roster and modify to fit your projects and work style.
Best practices for simplifying the TI process:
- Define a clear scope of work, include drawings, specifications, material selections, and desired start/ completion dates if possible.
- Develop a realistic schedule, accommodating for delays from designers, City approvals, material lead-times, and unforeseen construction challenges.
- Prepare a concise budget based on a clear set of deliverables including approved drawings, specifications, and/or material finishes.