In the Spotlight: Buildout Provisions in Office Leases

Who is responsible for paying for the work necessary to prepare the premises for tenant to move in and conduct its business?

Again, only three possible answers: tenant or landlord or, as in many cases, each of tenant and landlord is responsible for a portion of the cost.'

Tenant Performs Buildout'

With this scenario, the tenant is hiring a general contractor to construct its space according to plans prepared by the tenant's architect. The plans and the contractor are subject to the approval of the landlord. The tenant, in this instance, accepts the premises “as is.” There may be improvements in the space that will be utilized or the tenant has accepted the obligation to demolish all existing improvements before commencing its work. The tenant typically gets a cash allowance from the landlord to pay for the buildout, and a period of free rent to complete the work and move in.

This scenario puts the onus on the tenant to complete the buildout before its obligation to pay rent starts. As a result, the tenant will want to have strict time limits on the landlord's approval rights and “deemed approved” provisions in the event the landlord fails to respond within such time periods. The general contractors and major subcontractors that the tenant intends to bid the work should be pre-approved by the landlord in the lease. If possible, the tenant should have the landlord approve preliminary plans in the lease, in particular, specialty items such as staircases between floors, raised floors, etc.

The tenant should try to obtain an extension of the free rent period in the event its construction is delayed for force majeure events and certainly for landlord delays. If the cash allowance is large enough, the tenant should request that it be used not only for the “hard costs” of construction, but also “soft costs” (permit fees, architect/space planner fees, etc.), furniture, fixtures and equipment (such as IT cabling, etc.), with any unused allowance credited against rent. The landlord, on the other hand, will have a lease provision that details the disbursement of the cash allowance similar to disbursements of a construction loan.

Landlord Performs Base Building Work and Tenant Performs Buildout

In many instances, the space may not be in the condition to commence the tenant's work. Often, the existing improvements need to be demolished or other work, often referred to as “base building,” needs to be done. This work is typically done by the landlord's contractors, at landlord's cost.'

The tenant will want the lease to provide that such demolition and/or base building work is at the landlord's sole cost. Often, the lease simply says, “the premises shall be delivered with all improvements fully demolished and removed.” Well represented tenants will want the lease to contain much more detail, including assurances that the premises will be asbestos free. For instance, should certain improvements such as sprinkler systems and HVAC ductwork remain?

The tenant is often facing an expiration date under its existing lease and will also want a deadline imposed on the landlord to complete its work in order to give the tenant sufficient time to complete its own work and move in. Missing the deadline would have monetary consequences to the landlord and possibly a termination right. The tenant should ask for some advance notice of completion of the landlord's work to enable it to be as ready as possible to commence its own work.'

The landlord generally should be willing to provide many of these assurances and should document in a written notice to tenant the “delivery date” of the premises, which will start the clock on tenant's free rent period.

Landlord Performs Buildout

The Building Standard Workletter

When the landlord agrees to perform the buildout, it is sometimes referred to as a “turn key” lease. Typically, but not always, the “turn key” lease is for smaller space. The “turn key” lease is often used as a marketing tool to lure smaller office tenants, who do not have the internal resources, experience or inclination to plan and supervise a buildout. Typically, the building has a “building standard workletter” that the landlord has developed with its architect and can show potential tenants other tenant space built to that specification.

For the landlord, the lease should simply state that the landlord agrees to complete the work shown on an exhibit. This exhibit should contain as much detail as possible, but the execution of the lease cannot wait for full construction drawings to be attached. As a result, what is attached is a preliminary space plan layout (showing partitions, furniture layout, etc.) and a specifications list describing the improvements and finishes in some detail (sometimes referred to as the workletter).

In my experience, if not managed properly, this arrangement can lead to delays in signing the lease. Often, the business agreement reached between principals and their brokers is expressed fairly simply in a term sheet or letter of intent. A typical formulation is: “The landlord agrees to build out the premises in accordance with the building standard workletter with the finishes substantially the same as in Suite XYZ of the building.”

However, as the space-planning process begins with the tenant working with the landlord's architect, requests are often made by the tenant that are beyond the so-called building standard workletter. This process will then lead to a portion of the work that will be performed by the landlord at the tenant's cost, which in turn leads to the tenant having to be sure that the cost is the lowest possible. This arrangement can lead to all sorts of problems by injecting the tenant into the landlord's bidding and contract arrangements with the contractors.

In addition, a landlord will also be pushing for lease execution when the tenant is still “tinkering” with the space plan and its requirements. I have found that in today's markets, landlords have to be patient and are without backup deals. I often recommend signing up the lease with the plan and specs as preliminarily agreed to, with the right of the tenant to request changes within a 10-20-day period, with all such changes being at the tenant's cost.

The Allowance Budget

Other leases will have the landlord agree to perform the build-out, but will allow the tenant to work with the landlord's architect in developing the plans and specs. The space-planning services are typically paid for by the landlord. The landlord, however, provides the tenant with a budget ($X per rentable square foot). The tenant is responsible for all costs above that budget.

There are several problems with this approach. As part of space planning service, the landlord will often have the architect or a contractor provide preliminary itemized pricing to the tenant to assist the tenant in making choices. However, in the end, the tenant will need to have some input in the bidding process since it is writing out the check above the allowance budget. Documenting this arrangement can be done, but the result, in reality, may not be optimum for either party. What often happens is that the landlord simply agrees to bear the risk and build out the space per the tenant's plans, or the tenant agrees to build out the space with the landlord providing a cash allowance.

Issues to Address

When a landlord agrees to perform the buildout, the issues facing the parties are cost and timing. A landlord will protect itself by providing that the tenant agree to pay for all costs associated with change orders in work requested and approved. The tenant will generally have to agree to this protection in some form, but it should consider requesting dollar credits for work that is dropped or costs saved as part of such change order request. The easiest example to think of is carpeting. If the tenant wants to select a more expensive carpet after the lease is signed, it should be given a dollar credit for the initial carpet selected that was part of the budget.

As for timing, the tenant will certainly want the lease to have a time deadline for completion of the landlord's work, and subject the landlord to monetary penalties for missing the deadline. The size of these penalties is often linked to holdover rent the tenant may face in under its existing lease. The tenant will also want a termination right if the build-out is not done by a later outside date.

Most landlords will agree to these provisions with certain caveats. First, the dates selected will have some period of time that serves as a “cushion” ' typically, 30-60 days for monetary penalties and longer before a termination right is triggered. Second, the dates agreed to will be subject to extension for “tenant delays.” This typically covers delays caused by a tenant's failure to respond to a request for approval in the time period required by the lease, or by delays caused by a change order in the work requested by the tenant. Third, the dates agreed to will be subject to extension in the event of a “force majeure” event, which should include labor strife and other causes beyond landlord's reasonable control.

Conclusion

In the end, the objective is to get a lease signed expeditiously that clearly reflects the objectives of the parties. The work for leasing counsel is to recognize the risks inherent in the build-out approach decided upon at an early stage for BOTH parties, and then negotiate and draft a lease that creates a roadmap for dealing with the risks over the three-to-nine-month build-out period after the lease is signed.

Anthony Casareale, a member of this newsletter's Board of Editors, is a Partner with Di Santo Bruno LLP, resident in the Miami and New York offices. He can be reached at
[email protected].'

A critical consideration in a tenant's office leasing decision is the aesthetic and functionality of its potential new space. For the landlord, getting from a signed lease to a tenant-in-possession paying rent is a critical transition. The signed lease should provide both parties with a clear roadmap to achieving a mutually acceptable result: a rent-paying tenant in possession of space built to its full expectation in an expeditious manner and at a cost to both landlord and tenant contemplated at the lease signing.'There are several matters to be addressed in preparing this roadmap.'

Who is responsible for the work necessary to prepare the premises for the tenant to move in and conduct its business?

The answer to this question determines, in almost every case, when the commencement date and, more importantly, the rent commencement date of the lease will occur. There are only three possible answers ' tenant or landlord or, as in many cases, each of tenant and landlord is responsible for a portion of the work. To be absolutely clear, the work to be done by the responsible party is hiring the contractor(s) to perform the work.'

Who is responsible for paying for the work necessary to prepare the premises for tenant to move in and conduct its business?

Again, only three possible answers: tenant or landlord or, as in many cases, each of tenant and landlord is responsible for a portion of the cost.'

Tenant Performs Buildout'

With this scenario, the tenant is hiring a general contractor to construct its space according to plans prepared by the tenant's architect. The plans and the contractor are subject to the approval of the landlord. The tenant, in this instance, accepts the premises “as is.” There may be improvements in the space that will be utilized or the tenant has accepted the obligation to demolish all existing improvements before commencing its work. The tenant typically gets a cash allowance from the landlord to pay for the buildout, and a period of free rent to complete the work and move in.

This scenario puts the onus on the tenant to complete the buildout before its obligation to pay rent starts. As a result, the tenant will want to have strict time limits on the landlord's approval rights and “deemed approved” provisions in the event the landlord fails to respond within such time periods. The general contractors and major subcontractors that the tenant intends to bid the work should be pre-approved by the landlord in the lease. If possible, the tenant should have the landlord approve preliminary plans in the lease, in particular, specialty items such as staircases between floors, raised floors, etc.

The tenant should try to obtain an extension of the free rent period in the event its construction is delayed for force majeure events and certainly for landlord delays. If the cash allowance is large enough, the tenant should request that it be used not only for the “hard costs” of construction, but also “soft costs” (permit fees, architect/space planner fees, etc.), furniture, fixtures and equipment (such as IT cabling, etc.), with any unused allowance credited against rent. The landlord, on the other hand, will have a lease provision that details the disbursement of the cash allowance similar to disbursements of a construction loan.

Landlord Performs Base Building Work and Tenant Performs Buildout

In many instances, the space may not be in the condition to commence the tenant's work. Often, the existing improvements need to be demolished or other work, often referred to as “base building,” needs to be done. This work is typically done by the landlord's contractors, at landlord's cost.'

The tenant will want the lease to provide that such demolition and/or base building work is at the landlord's sole cost. Often, the lease simply says, “the premises shall be delivered with all improvements fully demolished and removed.” Well represented tenants will want the lease to contain much more detail, including assurances that the premises will be asbestos free. For instance, should certain improvements such as sprinkler systems and HVAC ductwork remain?

The tenant is often facing an expiration date under its existing lease and will also want a deadline imposed on the landlord to complete its work in order to give the tenant sufficient time to complete its own work and move in. Missing the deadline would have monetary consequences to the landlord and possibly a termination right. The tenant should ask for some advance notice of completion of the landlord's work to enable it to be as ready as possible to commence its own work.'

The landlord generally should be willing to provide many of these assurances and should document in a written notice to tenant the “delivery date” of the premises, which will start the clock on tenant's free rent period.

Landlord Performs Buildout

The Building Standard Workletter

When the landlord agrees to perform the buildout, it is sometimes referred to as a “turn key” lease. Typically, but not always, the “turn key” lease is for smaller space. The “turn key” lease is often used as a marketing tool to lure smaller office tenants, who do not have the internal resources, experience or inclination to plan and supervise a buildout. Typically, the building has a “building standard workletter” that the landlord has developed with its architect and can show potential tenants other tenant space built to that specification.

For the landlord, the lease should simply state that the landlord agrees to complete the work shown on an exhibit. This exhibit should contain as much detail as possible, but the execution of the lease cannot wait for full construction drawings to be attached. As a result, what is attached is a preliminary space plan layout (showing partitions, furniture layout, etc.) and a specifications list describing the improvements and finishes in some detail (sometimes referred to as the workletter).

In my experience, if not managed properly, this arrangement can lead to delays in signing the lease. Often, the business agreement reached between principals and their brokers is expressed fairly simply in a term sheet or letter of intent. A typical formulation is: “The landlord agrees to build out the premises in accordance with the building standard workletter with the finishes substantially the same as in Suite XYZ of the building.”

However, as the space-planning process begins with the tenant working with the landlord's architect, requests are often made by the tenant that are beyond the so-called building standard workletter. This process will then lead to a portion of the work that will be performed by the landlord at the tenant's cost, which in turn leads to the tenant having to be sure that the cost is the lowest possible. This arrangement can lead to all sorts of problems by injecting the tenant into the landlord's bidding and contract arrangements with the contractors.

In addition, a landlord will also be pushing for lease execution when the tenant is still “tinkering” with the space plan and its requirements. I have found that in today's markets, landlords have to be patient and are without backup deals. I often recommend signing up the lease with the plan and specs as preliminarily agreed to, with the right of the tenant to request changes within a 10-20-day period, with all such changes being at the tenant's cost.

The Allowance Budget

Other leases will have the landlord agree to perform the build-out, but will allow the tenant to work with the landlord's architect in developing the plans and specs. The space-planning services are typically paid for by the landlord. The landlord, however, provides the tenant with a budget ($X per rentable square foot). The tenant is responsible for all costs above that budget.

There are several problems with this approach. As part of space planning service, the landlord will often have the architect or a contractor provide preliminary itemized pricing to the tenant to assist the tenant in making choices. However, in the end, the tenant will need to have some input in the bidding process since it is writing out the check above the allowance budget. Documenting this arrangement can be done, but the result, in reality, may not be optimum for either party. What often happens is that the landlord simply agrees to bear the risk and build out the space per the tenant's plans, or the tenant agrees to build out the space with the landlord providing a cash allowance.

Issues to Address

When a landlord agrees to perform the buildout, the issues facing the parties are cost and timing. A landlord will protect itself by providing that the tenant agree to pay for all costs associated with change orders in work requested and approved. The tenant will generally have to agree to this protection in some form, but it should consider requesting dollar credits for work that is dropped or costs saved as part of such change order request. The easiest example to think of is carpeting. If the tenant wants to select a more expensive carpet after the lease is signed, it should be given a dollar credit for the initial carpet selected that was part of the budget.

As for timing, the tenant will certainly want the lease to have a time deadline for completion of the landlord's work, and subject the landlord to monetary penalties for missing the deadline. The size of these penalties is often linked to holdover rent the tenant may face in under its existing lease. The tenant will also want a termination right if the build-out is not done by a later outside date.

Most landlords will agree to these provisions with certain caveats. First, the dates selected will have some period of time that serves as a “cushion” ' typically, 30-60 days for monetary penalties and longer before a termination right is triggered. Second, the dates agreed to will be subject to extension for “tenant delays.” This typically covers delays caused by a tenant's failure to respond to a request for approval in the time period required by the lease, or by delays caused by a change order in the work requested by the tenant. Third, the dates agreed to will be subject to extension in the event of a “force majeure” event, which should include labor strife and other causes beyond landlord's reasonable control.

Conclusion

In the end, the objective is to get a lease signed expeditiously that clearly reflects the objectives of the parties. The work for leasing counsel is to recognize the risks inherent in the build-out approach decided upon at an early stage for BOTH parties, and then negotiate and draft a lease that creates a roadmap for dealing with the risks over the three-to-nine-month build-out period after the lease is signed.

Anthony Casareale, a member of this newsletter's Board of Editors, is a Partner with Di Santo Bruno LLP, resident in the Miami and New York offices. He can be reached at
[email protected].'