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Landlord Incentives

Financial Incentives From Landlords

Landlords provide financial incentives to tenants in the form of work and free rent .
In general, landlords want to provide tenants with an incentive to lease space in their buildings.
Landlords' willingness to provide these incentives depends on:

  • The strength of the market
    If there are few availabilities in a given market or submarket, the landlord has greater leverage in negotiations. If there is a lot of vacancy in a particular market or submarket, the tenant has greater leverage in negotiations.

  • The tenant's financial position
    The landlords' desire to have a particular tenant lease space in its building for reasons such as tenant's financial position or "credit", or the tenant company's stature in a particular industry that the landlord wants in the building. 

  • The landlord's financial position
    The landlord's ability to grant concessions is often governed by the money that it has financed or has on hand to grant as concession dollars.

Work

This discussion focuses primarily on space that requires moderate to significant construction, particularly raw space.

If the landlord is leasing the space as pre-builts or "as is", you should not expect much, if any, in financial incentives to make alterations to the space. If you take space "as is", you may be able to negotiate a minimal cash allowance for "paint and carpet" which may equate to something in the range of $5-$8 psf in the Manhattan office market.

Landlords quote work incentives in different ways and using different lingo. The basic issues that should concern you are: (1) who is responsible for the doing the work; (2)who bears the construction risk; and (3) how much of the total cost of all of the work required is the landlord offering in cash and/or in actual work.

The most typical ways and language used by landlords in offering incentives for tenant work are as follows:
 

Cash Allowance

A common way for landlords to provide work incentives is for the landlord to agree to provide a specific amount of money typically quoted as a per square foot allowance. While the most common way is to offer cash, landlords may offer free rent in lieu of cash allowance (see below). The tenant would be responsible for any costs in excess of the cash allowance. An example is as follows:

  $/psf
Landlord cash allowance $30.00
Total tenant construction cost $70.00
Amount tenant will pay $40.00

For a 3,000 square foot lease, the tenant outlay in the above example would be $120,000.

Responsibility for construction.
With this type of arrangement, the tenant is then generally responsible for building the space including hiring the general contractor or construction manager. Tenants can of course hire appropriate consultants such as a project manager to help them, but this method will generally require a much greater time and effort commitment on the part of the tenant regardless of which consultants are used.

Payment process.
Landlords typically pay the allowance in arrears upon receipt of agreed-upon documentation or invoices. The tenant therefore may initially have to come out of pocket for an even greater amount than the $120,000 in the example above, and then be repaid after some period by the landlord.

Use of Funds.
The landlord will typically require that a majority of the cash allowance be applied to "hard costs". Hard costs are longer-lasting improvements to the space such as HVAC equipment and ducting, walls and plumbing. These types of expenditures help benefit the long-term value and viability of the space. Landlords prefer that as much of the cash as possible they give you go to improve the value of the building. In contrast, tenants prefer that the cash given by landlords be applied to all cost expenditures including consultant fees, furniture, artwork, refrigerators, etc. that do not necessarily bring long term value to the space.

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Free Rent in Lieu of Cash Allowance

In this instance free rent is given to the tenant to offset money it commits to spend to improve the space.

Pre Built

As the name implies, the landlord has already built out the space to general specifications that it thinks will meet the requirements of most small businesses. In the recent tight market, landlords have begun building out space before they have specific tenants in mind. Pre-builts are typically for smaller spaces in the 2,000 to 7,000 square foot range. With pre-builts, landlords will generally offer no work, except for possibly very minor modifications. Pre-builts obviously offer the advantage of being able to move-in quickly and begin business if the already completed build out meets the company's needs.

Landlord Workletter

Landlord workletters were common in the 1980's but are infrequently offered today. With this method, the landlord delivers a letter that lists the work it will do (i.e. provide so many feet of drywall, number of doors, yards of carpet etc.). This method requires a good understanding of all of the construction needs of the space. It also requires extensive negotiations during the lease process because it requires the attorneys to carefully craft the language and appropriately reflect what quantity is received.

The issue in this process is to insure that the landlord does not substitute materials of lesser quality. Someone from your company or an outside consultant/project manager needs to be closely involved with the construction process to ensure that you receive the materials and execution for which you bargained.

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NBI (New Building Installation)

As initially coined, this term implied that the landlord would deliver a build-out based on its pre-determined specifications (i.e. certain HVAC capacity, light fixtures, carpeting, wall finishing, etc.) However, you should inquire about the specific intentions of the landlord because the provision of the NBI could be: (1) the landlord builds out the space and delivers it to you - like "Turnkey"; (2) the landlord provides you with a Cash Allowance that covers what the landlord thinks a build-out to its pre-determined specifications will cost you.
Turnkey/Build-to-suit/Design build
These terms of art imply that the landlord bears all of the construction risk and delivers completed space to you based on agreed upon specifications. As with the Landlord Workletter method, these methods require negotiations with the landlord and may require coordination and oversight to ensure that you receive the build-out to which you agreed.
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Free Rent

Free Rent is typically quoted as a number of months of abatement in base rent at the beginning of the lease term. Free rent abatement does not typically include abatement of electric, operating or tax costs and escalations. Less common is abatement of months of rent later in the term. Free rent is market-driven but usually is intended to cover at least the construction time period, if any, required to build out the space. Additional free rent after move-in is negotiable. With pre-built space, the landlords will less likely want to give free rent because they have invested money up front and want to begin receiving a return quickly.

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