Tenant improvements: six budget buckets explained

The construction quote is the fit-out cost everyone studies, and it rarely breaks the budget.

What breaks the budget sits outside the builder's contract: professionals, permits, equipment nobody called construction, rent on unused space, and the obligation you create when you build to remove it all at the end.

This page maps tenant improvements into six budget buckets. The amounts inside each one vary by building, by trade availability and by what the survey finds behind the ceiling, so project prices come from your own quotes, your landlord and your local building department. The structure does not vary.

What to take away

Bucket one: design and advice

Somebody has to draw it, and somebody has to check it against the rules before a builder prices it. In practice that is an architect or interior designer, a mechanical, electrical and plumbing (MEP) engineer, and, on anything beyond a simple fit-out, a code or permitting consultant who knows the local reviewers.

Design fees are usually a share of the construction value, which means they move when the scope moves. Ask how the fee behaves if the scope changes. Small jobs are often billed as a fixed fee or at an hourly rate instead, and the code or permitting consultant almost always bills hourly.

Bucket two: the construction contract

This is the builder's number, and its usefulness depends entirely on how completely the drawings describe the job. A price built on drawings full of provisional allowances is a forecast, not a quote. Ask for the schedule of values, which shows what each element costs, and compare quotes element by element rather than at the bottom line.

Two things inside this bucket routinely move: anything hidden behind an existing surface and anything the reviewer asks you to change. Ask the builder to identify a construction contingency for those risks, and decide in advance who authorizes spending it. The AIA says 5 to 10 percent is a common contractor contingency range, based on the risk, difficulty, and complexity the contractor faces. Keep the contractor contingency separate from any contingency you hold as tenant.

Bucket three: the landlord's own charges

These sit outside the builder's contract and are frequently missed. The usual ones are the landlord's construction supervision or management fee, the landlord's own architect or engineer reviewing your drawings, mechanical and HVAC tie-in work and after-hours use of the building's systems, building insurance during construction, the landlord's legal fees for the work letter and any consent, and charges for the freight elevator, the loading dock or utilities used during the work.

Ask for this list in writing before the lease is signed, with an amount or a rate against each item rather than a category. Afterwards there is no room left to reduce any of it.

Bucket four: permits, reviews and old materials

Application fees are the small part. The larger part is the professional time spent producing what the reviewers want and answering them. The permits themselves are usually the building permit and plan review from the city or county building department, separate electrical, plumbing and mechanical permits, fire department review of sprinklers and alarms, a sign permit, and a certificate of occupancy or an amendment to the one the building already holds. Accessibility requirements under the Americans with Disabilities Act and the state or local accessibility code run through all of it, and a change of use can need zoning approval as well.

Where a building is old enough, two federal programs can add scope before construction starts. Disturbing lead paint in some buildings brings the EPA's renovation, repair and painting program into play. Work touching asbestos-containing materials falls under the asbestos emission standards, the National Emission Standards for Hazardous Air Pollutants (NESHAP), enforced by the EPA and, in most states, by the state or local air agency, and OSHA's asbestos rules cover the people doing the work.

A survey before you price the job is cheaper than a stop-work order during it.

Bucket five: outside the contract entirely

Each of these has a lead time of its own, and two of them commonly arrive after the space is ready. Give each one an owner, a date and a line in the same spreadsheet as the construction cost.

Bucket six: time

Rent on a space you cannot trade from is a fit-out cost, and it is the one nobody budgets. During a fit-out two rents can run at once: the rent on the new space, which usually starts on the commencement date, and the rent on the space you have not left yet. If the lease starts the clock on a fixed date and the review queue slips, you are paying for empty space out of revenue you are earning somewhere else, or out of nothing.

Model the whole period from commencement to first productive day, at the rent and charges that apply, at three durations: the plan, the plan plus a review cycle, and the plan plus a serious surprise. That third number is the one worth showing to whoever signs.

The obligation you create at the end

Building something creates a duty to deal with it later. What comes out, what stays, and who decides depends on the lease, usually the alterations article and the surrender or restoration clause. Often that answer stays vague until the term is nearly over.

The legal idea underneath is the tenant's duty not to damage the property's value, the old common-law doctrine of waste. Your actual obligation is contractual and specific to your document.

Settle three points in writing while you have bargaining power: must you remove your work; may the landlord require it at their option and when must they say so; do installed items become the landlord's property?

Put a provision in your accounts for whatever survives negotiation. The bill is normally a demolition or removal quote at the end of the term, so it is unknown when you sign; ask for a written cap or an agreed schedule in the lease while you still have something to trade for it.

A restoration bill at term's end brings no revenue and cannot be deferred.

Putting it together

The rent side of that combined figure is covered in Ten commercial lease structures in plain terms and where each puts the risk. How a contribution is financed and released is in Tenant improvements as a construction project hidden inside a lease.

If the permit queue is the item you cannot estimate, Zoning and permits are three separate systems that nobody else in the deal owns explains who to ask. Where the fit-out is large relative to the term, Commercial property buying requirements: which one controls your closing date is worth reading before you commit capital to somebody else's building.

Common questions

How much contingency is enough?

The builder's contingency has a common benchmark described above. For your own contingency, name the specific unknowns, price the worst credible version of each, and hold that. Keep the owner's contingency separate from the allowances inside the builder's contract, so you can see which risks the contractor has priced and which ones you are carrying.

Does a larger contribution mean a better deal?

Not by itself. It is capital being recovered through your rent. Compare the whole occupancy cost over the term, and ask what happens to the contribution if you leave early.

Should the fit-out be capitalized or expensed?

That is an accounting question with tax consequences, and it depends on what you built and where. Take it to your accountant with the schedule of values in hand rather than deciding it yourself.

Can I avoid the restoration cost?

Sometimes, by negotiating that your work stays. Whether that is possible depends on what you built and who the next occupier is likely to be, and it is much easier to agree at the start than at the end.