Leasing Should Involve Your Contractor
Why Your Contractor Needs to be an Integral Part of the Leasing Process
By Dean Blackey
The #1 thing that will kill your deal and what to do about it.
One of the number one “deal killers” we see these days when it comes to leasing is construction costs, specifically when it comes to Tenant Improvement.
It is no secret that construction costs have gone through the roof in recent years. Simple tenant fit-ups such as paint and carpeting and moving a couple of walls that were once $15/SF are now $30/SF. Gut rehab of old-generation spaces can quickly get above $70/SF in the blink of an eye.
Interestingly, it is not necessarily the cost itself that is derailing the deals so much as when this part of the equation gets addressed during the deal process. Simply put, landlords are waiting too late in the game to get their contractor involved.
For years, Landlords felt comfortable trading proposals back and forth and “guesstimating” the cost of a tenant’s proposed build-out based on past experience. For the most part, construction pricing was relatively stable, and the price you paid a year ago wouldn’t be much off from a similar fit-up 12 months later.
Even when putting a cap on the improvement allowance (not to exceed $xyz/SF), they were still willing to hash out most of the pertinent business terms before finally engaging their contractor to price up the improvements.
The issue we face today is that the discrepancy between today’s “guestimate” and reality can sometimes be an enormous delta which can be catastrophic to a deal when it comes into play after both parties think they have a deal in place.
Having already set the expectation on the major business points of the deal, the landlord’s broker is forced to go back to the tenant and explain that these terms now need to be reevaluated entirely to either increase the rental rate, length of the term or likely both in order to accommodate the actual construction costs. This is not to say that bringing these costs to light sooner will necessarily change the deal’s outcome, but it will at least avoid the “bait and switch” sentiments we are hearing from many tenants.
Additionally, “Term” has become one of the most significant sticking points. The two forces at play are pulling today’s landlord and tenant in opposite directions. For the Tenant, the repercussions of the Pandemic and uncertainty about the future of the US economy have decision-makers wary about committing to longer-term leases. In our day-to-day encounter with many businesses, there appears to be still a majority of Tenants who still consider themselves in the “trial phase” of the hybrid/work-from-home model.
On the opposite side of the coin, with construction prices being what they are, Landlords can no longer make economic sense of leases under five years for anything more than an “as-is” or “Paint and Carpet” type deal. If, for example, your class B building in Marlboro is doing deals at $24/SF with $8/SF in operating costs, an “average” build-out allowance of $40/SF will render the first 3 years just above net zero.
Of course, every deal is different, and buildings that are afforded a higher asking rate can obviously absorb these construction costs more easily. However, on the flip side, we often see the tenants willing to pay a higher rental rate expect a commensurate (more expensive) build-out in return.
Obviously, contractors have been extremely busy these past few years, which is why establishing a solid working relationship is more important than ever. The difference between a GC taking a week to pull an estimate vs. a month can mean the difference between landing a deal or losing it.
The earlier you can get a contractor to price out a tenant’s desired build-out, the earlier the Landlord can set a realistic expectation for what it will take to get a successful lease over the goal line
Realistic pricing and responsiveness will give your building a competitive edge in the current office market