Derek Miller, CBRE | The Boulos Company

I was once told that a good way to characterize a lease agreement is to view a pile of on money on a table; this represents the funds involved in the transaction. As things are requested of a landlord over the course of negotiation, money is taken off the table. As monetary concessions are made by the tenant and/or improvements are made to the building at the tenant’s expense, money is added to that pile. This is a very rudimentary way of looking at transactions, which can be extremely complicated depending on the size of the deal, but it’s not too far off the mark.

In almost every lease deal, aside from the rent that is to be paid, the work involved in the deal is usually the most hotly negotiated point. It is unusual for a tenant to walk into a space, whether 1,000 s/f or 100,000 s/f, and hear the words “this is perfect, I’ll take it as-is.” For the most part, changes need to be made for the space in question to work for the prospective tenant’s business. Streamlining leasehold improvement negotiations is one of the most important roles a commercial real estate broker plays in the leasing process. The first step in any of these negotiations is to try to quantify anything and everything that is being considered from a work perspective. Contractors, plumbers, and electricians, while increasingly busy in an active market, will typically be happy to view a project and put together an estimate. This allows the landlord and tenant to have an informed discussion about how to get from A to B within the parameters of the deal, with the end goal being a signed lease.

Sometimes a property may be left in poor shape by a previous tenant, a common event when they had been in a location for a number of years. This may result in “base building” improvements that will likely need to be done at the landlord’s expense for any prospective tenant. These items can be small in the grand scheme of things, such as ceiling tiles, carpet, and/or paint. They can also be larger capital items like replacing a heating system, windows, or a roof. Landlords may also agree to cover, at their cost, base building improvements to a space at a tenant’s request as it will add value to the property, with potential utility to others going forward. Base building improvements are an investment landlords make to win a tenant’s business in a competitive marketplace. A good example of this type of investment into a property would be 22 Free St. in Portland. The building was recently purchased and the new landlord converted a first floor suite with office-like finishes into beautiful retail space by installing a sheetrock ceiling, hardwood floors, and a direct retail entrance. The façade and lobby were also improved. The renovations were in part a function of a lease with J Henry Salon, who relocated from Middle St. The result is greatly improved mixed-use property that is well positioned in a vibrant retail area within Portland.

Improvements that are not considered “base building” in nature can be classified as tenant specific improvements; i.e. items that are needed for the tenant’s business, but will have very little utility for anyone else. These type of improvements typically don’t add much value to the property and can actually result in “negative value” because the landlord will need to have them removed if and when that business relocates. In some cases, the landlord will ask that the tenant restore the space to its original condition at the end of the term. Tenant specific improvements typically are the responsibility of, you guessed it, the tenant. These improvements can be rolled into a business loan or paid in cash. One item that is almost always the responsibility of a tenant are its tel/data needs and any changes to the space therein. This is because each tenant’s internet and phone needs are different and there is a costly liability for the landlord if anything is not done properly.

There are many factors that play a role in the work that gets done as a function of a lease deal and who pays for what. The length of the lease, creditworthiness of the prospective tenant, the landlord’s experience, access to capital by both tenant and landlord, and debt on the subject property can all play a role. A well capitalized landlord may be willing to provide a space turn-key for a 10-year lease term and amortize the cost of those improvements over the term of the lease, financing the improvements for the tenant, in a sense. When a landlord is investing a lot of money up front, a longer lease is required. This makes the deal more bankable and/or saleable and also gives the landlord a reasonable assurance that they will be able to recover their construction costs. If a tenant has the ability to fund any leasehold improvements at their own cost, it can go a long way to simplifying the lease deal and ultimately results in the lowest occupancy costs. The lower cost of occupancy is in part due to the fact that the landlord will amortize the tenant improvement (TI) allowance at a certain percentage, usually between 8-10%. When tenants fund all or a majority of the leasehold improvements they will typically be able to get a lower lease rate, a shorter lease term, and possibly other lease concessions such as the landlord not requiring that a lease be personally guaranteed.

The reality of most lease deals are, like all things, dependent on the people involved. An experienced commercial real estate broker can help a landlord and tenant overcome obstacles that will arise and present creative solutions as to how certain objectives can be met. They will also know when to bring in other experienced professionals to help solve a particular problem within the deal, whether it be legal, design, or construction related. It is important to keep in mind that there is truly no wrong way to structure a lease deal as long as it meets the strategic real estate and business objectives of all parties involved.

Derek Miller is an associate broker at CBRE|The Boulos Company, Portland, ME.