Top 10 Tips for Negotiating Improvements in Industrial Real Estate Leases
Outside of build-to-suit projects, the average dollar per square foot magnitude of improvements negotiated in industrial leases is much less than other commercial real estate product types. One reason is industrial tenants will typically pursue and lease industrial spaces which are already acceptable for their needs, with minimal to no improvement required. In addition, the utility of industrial spaces is largely in its warehouse and manufacturing areas, areas which normally do not require significant improvement following vacancies.
Therefore, tenants can lack experience and market information when improvements are needed. They may not know how to structure negotiations to maximize their benefits and realize when a landlord is being reasonable or unreasonable in their position. To help them, the following is my top 10 tips for industrial tenants who want to negotiate the best tenant improvement structure with a landlord:
10. Understand what is customary in the market in regards to tenant improvements. Is there a standard tenant improvement allowance provided by landlords? If the cost of improvements exceeds the allowance, will landlords typically amortize the excess over the lease term and at what interest rate? Will most landlords manage and complete the improvements themselves? Answering these questions will help set expectations of internal stakeholders and provide guidelines to start negotiations.
9. Visually inspect the premises for areas of deferred maintenance and any missing amenities which would normally be present. I also recommend using a landlord questionnaire but when initially touring property any sign of deferred maintenance should be noted. In addition, recording any amenity deficiencies such as a below average sprinkler system, lack of life safety equipment, or no dock equipment can provide leverage in discussions regarding improvements.
8. Clearly understand and define any required improvements before entering negotiations. A tenant should generally understand what improvements will need to be performed and be able to communicate the list of those improvements to the landlord in the initial proposal or request for proposal. This does not mean there needs to be a tremendous amount of detail for each improvement nor make the assumption that the list won't change. However, it shows the landlord that you have taken the time to investigate your requirements and they can respond with any concerns early in the negotiation process.
7. Prioritize any desired improvements by their order of importance. Inevitably there will be situations where the tenant will choose certain improvements over others. By prioritizing their list of improvements at the beginning of negotiations, the tenant and their advisers will know which they can potentially sacrifice in order to negotiate the best lease possible.
6. When structuring improvement sections in a proposal or request for proposal, use separate provisions for any work to be performed by the landlord and work to be performed by the tenant. Well-designed improvement provisions often have a significant amount of detail including what improvements are being performed, who performs those improvements, and who pays for improvements. Separating those provisions by performance responsibilities makes it easy to categorize them further and notify the landlord of any improvements the tenant will be making themselves.
5. Watch out for construction management fees and the interest rate used in amortizing any tenant improvements. Landlord's will often charge a fee to manage the oversight of tenant improvements, which will often be deducted from a tenant improvement allowance as a percentage of the overall hard and soft costs or the allowance itself. However, these fees are often negotiable and can sometimes be eliminated completely. Similarly, if the landlord agrees to amortize the costs of any tenant improvements above an allowance they will almost always apply interest. As with the construction management fee, the interest rate is negotiable and should be reflective of the tenant's credit and the type of improvements being financed.
4. Consider alternatives to having the landlord manage tenant improvements. Just because the landlord is willing to manage tenant improvements under an allowance or amortized loan does not mean it is the best arrangement for the tenant. Alternatives such as hiring a general contractor, using an in-house facilities team, or financing improvements with lines of credit or existing banking relationships may be advantageous in certain situations.
3. Address restoration requirements in the proposal or request for proposal. Ideally tenants would have no obligation to remove any tenant improvement approved by the landlord. While the removal of tenant-specific improvements are understandably concerning to a landlord, improvements such as additional offices or restrooms could be difficult and costly for a tenant to remove at the end of their occupancy.
2. Know the value of tenant credit and lease term for tenant improvements. Creditworthiness is valuable to a landlord because it reduces risk. In the case of landlord funded tenant improvements, credit becomes a more significant concern because of the typical large capital outlays at the beginning of the lease. Tenants with above average credit should make the case to the landlord that they should receive better tenant improvement terms than average credit tenants have received historically. In addition, willingness to do a longer lease term usually means superior tenant improvement terms, but it is usually a good idea to ask for multiple term lengths for comparison purposes.
Realize that tenant improvements are just one part of the overall real estate cash flow for a tenant and landlord. Rather than forfeit unused tenant improvements, try to negotiate an equitable benefit in free rent or a reduction in the start rate. If no tenant improvements are needed, it may be worthwhile accepting an offered tenant improvement allowance at the beginning of negotiations and then using it to trade for improving other deal points later on. Negotiating a lease mostly boils down to perceived cost over time, so if you can convince the other party of the relative savings of an action, you will most likely get them to agree to it.
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