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Wins & Insights

Tenant Leasing Illustrated – March 2014 – Gold Medals, Curling and Your Lease

Gold Medals, Curling and Your Lease

It is that time when we awaken from our winter doldrums, put aside our snow shovels and are treated to astounding athletic feats in the great outdoors.

No, I do not mean Punxsutawney Phil. I am talking about the Sochi Winter Olympics.

I must admit that, while I like sweeping as much as the next guy, curling and some of the other Winter Olympics sports struggle to pull me away from True Detective and the 72 daily college basketball games.

But the old school Soviet style political drama is priceless. When one of the five snowflakes in the opening ceremony did not burst into the fifth Olympic ring as expected, I could only think of the hapless responsible contractor having his bags packed for him to Siberia.

In fact, the construction for the Olympics has generally been a mess, with hotels, apartments, roads and shopping locations remaining uncompleted at the start of the games. Most incredibly, Vladimir Putin’s original estimate of the aggregate cost ballooned from $12 Billion to roughly $50 Billion!

Construction delays, unexpected costs, cold blooded dictators. That certainly sounds like a good segue for a discussion of how costs can quickly get out of hand when a landlord builds out a tenant’s space.

There are too many aspects of a tenant build out to handle in a single newsletter, so we are focusing today on costs.

A tenant needs to build out its new space. Many tenants, particularly large tenants with large dollars at stake and the wherewithal to manage the project, will take an allowance from the landlord and build out the space themselves.

Many other tenants prefer to have the landlord build out their space. They know that there is some profit built in for the landlord, but can accept this in exchange for the certainty of cost and the ability to pass the construction headaches over to the landlord.

But this is not necessarily a reasonable assumption; after all, if runaway costs can get the better of a ruthless KGB alum like Vlad, with the ability to go all Stalin on his contractors, it can happen to anyone.

Most leases in which the landlord builds out the premises provide that work in excess of the “building standard” and costs in excess of a certain aggregate amount (or amount per square foot) will fall on the tenant. This means that the tenant must do its due diligence and have a good idea beforehand as to what it expects to be built and what this cap will buy.

Just say nyet to surprise construction costs by following these nine suggestions:

  • Clearly define the scope of your landlord’s work. The more specificity, the better. Ideally, you will attach detailed plans and specifications as an exhibit to your lease but, if that is not feasible, the more that is agreed upon up front, the less likely your landlord can claim that portions of what you thought were included as part of “Landlord’s Work” are instead “extras” involving additional cost.​
  • Beware of the term “building standard”. You must clearly define in your lease what it means for your landlord to build to building standard. For many leases that we see, “building standard” boils down to what the landlord says it means at any given time. If possible, it is better to refer instead to your plans and specifications or, alternatively, point to some other objective standard, such as a prior build out in the building.​
  • Become involved in the bidding. Make sure your lease requires competitive bidding among a minimum number of independent contractors (e.g., three or four), with at least one of the bidders a reputable contractor that you have selected. Also, allow yourself the right to “value engineer” the bids once received, i.e., to revise your plans and specifications in order to bring down the cost before the work starts.​
  • Require an “open book” process. Do not let your landlord’s apparatchiks run the show. Make sure that you stay involved and informed by having the right to review (and reviewing) all bids and invoices. Da, as they said in cold war days, “trust but verify”.​
  • Exclude “base building work” from the equation. Improvements to the building and its systems should be your landlord’s responsibility and not be included in the aggregate figure that your landlord has agreed to spend on your build out.​
  • Include a reasonable process for change orders. You need the right to change direction or include additional items during the construction process, but in that instance your landlord is entitled to put the incremental cost on you. Provide that change orders will be performed at cost with no mark-up or, if overhead and profit are included, specify these amounts up front.​
  • Address landlord supervisory fees. If your landlord is running the construction process, it is not unreasonable for it to include a supervisory or project management fee, but this fee should be at a market rate and clearly delineated so that there are no surprises.​
  • Hire your own project manager. Your landlord is in the real estate business and it is likely that you are not. Retain an expert project manager and/or architect to be your eyes and ears and your advocate, even though your landlord is building the improvements.​
  • Provide for expedited arbitration to resolve disputes. With a quick and objective method of dispute resolution, such as expedited arbitration, you will have the opportunity to resolve disputes before a disinterested third party.​

It does not necessarily mean that your paranoia is rising to the level of General Jack Ripper from Dr. Strangelove (“fluoridation is the most monstrously conceived and dangerous communist plot we have ever had to face…”) just because you retain a healthy skepticism about how your landlord’s construction could lead to unpleasant surprises. Avoid the construction gulag by following the suggestions above and you can walk away with a gold medal.​