Overview:

When a landlord pays for modifications to a tenant’s space the Landlord will charge a higher rent than if a tenant takes the space in its "as is" condition. Unfortunately, for a tenant trying to assess a fair rent to pay based on certain alterations, the impact on the rent is not as straightforward as, for instance, the amortization of a loan. The amount that the rent will increase should/will depend on a number of factors; the initial condition of the space, the type of alterations, the credit of the tenant, the credit of the landlord, how much money the landlord puts into the space, number of years left in the lease term, overall building marketability/quality, the landlord’s future "vision" of the building, the amount the tenant will be "investing" in the space, and most importantly each landlord’s "read" on market trends and projected vacancies/risks.

What:

This discussion is intended to give some insights into what to expect regarding adjustments to your rental rate when you require the landlord to make alterations to your space as part of lease renewal or relocation negotiations.

Do not ever think the best negotiating strategy is to lock up a deal based on taking the space as is, then afterwards ask the landlord to put in alterations that would cost $10.00 per square foot.

Why:

It is important to understand to what extent the alterations create a burden or an asset to the landlord regarding subsequent tenant interest and overall building value. Then take this information as well as the cost of the work and consider this along with the research from steps 2 and 6. The result should be a "sense" of what/how increases or decreases in the alterations should impact your rent and by how much.

Renewal Negotiations are Different:

When you are renewing your lease, a lot of the above factors may not come into play.  The Landlord may put greater emphasis on how much it would cost you to lease alternative space. As an example, if the rent for the other space is $25/sf, your current landlord will have little incentive to go below, say $24/sf even if you don’t require any alterations (which equates to how much the landlord will save if they avoid making changes for a subsequent tenant).

Money You Can’t Save:

Many landlords consider it a necessary expense to make at least some modifications to the space with a new tenant just to maintain a desirable tenant pool in the building. This is one reason why a landlord might not give you as large a discount as the space would suggest you deserve if you forego doing alterations altogether.

A second consideration against getting a full discount is that the value of the landlord’s building is, to a large extent, a function of market values for similar buildings and therefore a function of the rental rate that the landlord’s space can achieve. As an example, if a tenant would tolerate used carpeting, walls in need of painting, poor lighting or ceiling tile system and poorly-sized offices, the landlord will be reducing the value of his building and the extent that he can refinance the building if he gave a discounted rent which reflects such a poor interior condition.

What changes should be on the landlord’s tab?

To the extent that you are installing improvements that will have no value for the subsequent tenant, you can expect the landlord to entirely amortize that cost within your lease term. However, where alteration costs will likely add value for subsequent tenants you should expect only a portion of the costs to be amortized over your lease.

As an example, light fixtures, particularly a good quality, high efficiency version, will last well beyond five years. Solid panel full height doors will last beyond five years; the ceiling tile/grid system, the sprinkler system and duct work in the ceiling to distribute heating and ventilating will last beyond five years. Based on these examples, a tenant could expect to pick up the cost "below the finished ceiling" as well as a portion of the cost of the ceiling. Carpeting, wall partitions, electric, light and HVAC placement resulting from your office layout are all costs that have little anticipated value for subsequent tenants.

How to estimate the impact of the alterations on a quoted rental rate:

Credit worthiness of the tenant

Subject to the "gnat" vs. "gorilla" discussion in Step 2, the landlord might expect a lower credit-worthy tenant to pay for their own alterations or demand a very large security deposit to protect the landlord in the event of a default.

For a high-credit quality tenant, we typically ask the landlord for a quote to provide "the factor by which the rental rate per square foot will increase for each $1 per square foot that tenant’s alterations cost increase". As a rough calculation, you might expect a good credit tenant to repay the landlord $2.50 per square foot per year for each $10 per square foot the landlord is required to spend on your space based on a five year lease term. However, the financial strength of both the tenant and the landlord can have a big impact on this number.