Office Buildout

[David Dorau]

I recently acquired 3200 sqft of vacant office space from a bank. It is divided into two 1600 sqft mirror image sections. I have planned out ways to break it down so that I can rent as little as 400 sqft. The commercial appraisal that was done has the fair market rent at $13/sqft. I have a tenant interested in the 400 sqft space but needs a lot of buildout including an additional small bathroom. I have never negotiated build out before and I understand that I was going to need to add some walls and outlets anyway. How do I decide how much is a reasonable allowance and how much I put on the tenant? In addition, how do I bill the tenants share out? Just divide by length of lease? Also, since the tenant is renting so little space, is there a percentage of rent I shouldn't go past? Any suggestions would be helpful. Thanks in advance.

[Eric Odum]

Not sure about your market, but in my market, if I asked a 400SF tenant to come out of pocket for 1 cent for buildout or for them to do any buildout on their own, they would run the opposite direction.  400 SF tenants are typically, really small operators and any unknowns regarding cost, workload, etc will send them running to the hills. 

Typically, we have a standard build out in mind with any property.  We estimate what we consider to be reasonable market  buildout and tell the potential tenant, "This is what we are willing to do.  If you need higher end or more buildout than standard, we need a lease to cover those costs, which typically includes longer terms and higher rates."  Again, 400 SF tenants tend to be really small operators and will just move on and try to find something built out that already suits their needs.  

The buildout allowance is based on returns....what is reasonable?  There is no set, standardized amount one allocates to allowance.  Each situation dictates its own parameters...cost of acquisition, how difficult it will be to find tenants for the space, functional obsolescence, etc  What I do know is there is a correlation between sophistication of the tenant and what variables they are willing to accept.  Smaller, mom and pop tenants, the kind that go in to 400 SF spaces are really tough...they typically do not have the financials for you to complete an expensive, non-standard buildout and hope they are going to pay you back through the lease.  When you try to push the additional risk/buildout on them, they know they don't have the experience, comfort level, time or money to accept the additional responsibility and risk, so they walk.  That is the paradox with small office tenants.