The biggest up-front expenditure in the entire leasing process is the cost of constructing space.

An important question to ask is: “How much cash on hand will I need to accomplish this move?”  And the time to answer that question is before you start looking for space.  You can eliminate many expensive surprises by determining your out-of-pocket expenses ahead of time.

Start by making a list of what you think you will need in the new space, as we learned in Chapter 2.

The only rule-of-thumb on office construction costs is that there is no rule-of-thumb.  Construction costs vary greatly from region to region.  Some of the highest cost areas are major city markets like New York City, Los Angeles, Chicago, etc.  Downtown office construction costs are greater due to the requirements of unions, difficulty of obtaining materials, city building codes and regulations, and a shortage of contractors.

A complete explanation of construction and out-of-pocket costs can fill many books, and many have been written on the subject.  In this chapter, we will review the most essential information that tenants need in order to understand the factors effecting the costs to build out space.  It is advisable for companies to enlist the help of a skilled designer or architect, as we will discuss in Chapter 9.

To attract new tenants, landlords typically provide a tenant allowance to construct space.  The allowance can be calculated in a dollar per square foot amount or with a lengthy document known as a work letter. The work letter describes the quantities of various building materials contributed by the landlord.  Because of the complexity of calculating work letters, they are mostly out of style in today’s fast paced business climate.

Whether you have a cash allowance or a work letter, it is essential for the tenant to determine up-front what it will cost to occupy a given piece of space in the way that tenant needs to.  In this way, a tenant can determine if the landlord’s construction allowance is sufficient to build out the office to meet the tenant’s specifications.

To make things simpler, tenants often are offered the option of letting the landlord construct the space.  This means that instead of the tenant hiring its own contractor, the landlord will offer to have his contractor build the space to the tenant’s specifications.  Since a good many tenants do not have construction expertise, many will take advantage of the landlord’s help.

On the other hand, if you choose to hire a contractor directly, the contractor will be responsible to do the job the way you want it done.  You the tenant, however, will then have the burden of supervision and the responsibility of making sure that the work is performed correctly and on time.

If you choose for the landlord to do the build-out, be aware that some landlords might inflate costs as construction work is one of their profit centers.  Before any work commences, the landlord should provide the tenant with an estimate of the cost of constructing the space to meet the tenant’s specifications.  A building-to-building or apples-to-apples method of comparing building proposals will be described in Chapter 8.

Amortization:

In today’s economy, a landlord prefers a lease term of five years in which to amortize the cost of the new tenant finish allowance.  To understand why, let’s look at an example.  If the landlord provides a tenant with a construction allowance of $15.00 per square foot for a five-year lease, the landlord’s costs would amortize to be $3.00 per square foot plus interest for each year of the lease.

$15.00 allowance ÷ 5 years = $3.00 per square foot plus interest per year.

If you shorten the term of lease to only three years, the $15.00 per square foot allowance amortized over three years computes to $5.00 per square foot plus interest per year.

$15.00 allowance ÷ 3 years = $5.00 per square foot plus interest per year.

You can see clearly now why landlords prefer the stability of a five-year lease.

Some of the other out-of-pocket costs tenants incur are the cost of moving furniture and equipment, wiring and installing telephones and computers, and printing new stationery and sales material.

Frequently, relocation is the time when new furniture is purchased to go along with the new office décor.  Furniture and office equipment may be purchased or leased.  The advice of your accountant is essential in understanding the advantages and disadvantages to your business of leasing versus purchasing office furniture and equipment.

          Secret No. 16 — A preliminary budget of out-of-pocket costs should be determined before you look for space.  Decide whether you are leasing or purchasing a new phone system or relocating the old one.  Are you going to be leasing or purchasing new furniture or are you planning on relocating the existing furniture?  Consult with telecommunications and furniture vendors to get a good handle on these expenses.  Some vendors will offer you the option to lease furniture or office equipment.  Discuss with your accountant which alternative works best for you.