Budget for Key Upfront Costs When Leasing Office Space

When tenants are in the market for office space, one of the first critical steps in the process is developing a real estate budget. Generally, brokers that specialize in representing tenants develop two distinct budgets to guide their clients, one that includes upfront expenses incurred prior to and upon signing the lease, and another that lists potential expenses relating to the lease itself, such as utilities, insurance and property management fees.

For insights on key upfront costs related to leasing office space, LoopNet spoke with Sandra Weiss, principal at Summit Commercial Real Estate. For more than 33 years, Weiss has worked as a tenant rep, negotiating on behalf of office tenants, from nonprofit organizations and for-profit firms, in the Washington, D.C., metro area.

Key Categories to Budget for Early

For overall context, Weiss shared a list of the major upfront expense items she reviews with clients when beginning the search for office space — a list that can serve as a point of reference for any tenant. She organizes the line items into three broad categories: lease-related expenses, construction-related expenses and move-related expenses.

Lease-related expenses

• First month's rent.
• Security deposit (refundable).
• Legal fees relating to lease negotiations.

Construction-related expenses

• Construction costs.
• Architecture and engineering fees.
• Landlord construction management fees.
• Permitting fees.
• Tenant project management fees.

Move-related expenses

• New furniture.
• Existing furniture liquidation.
• Telephone system (new or relocation of existing).
• Office equipment (new and/or relocation of existing).
• Audiovisual systems.
• Telecom/data cabling and infrastructure.
• Suite security system.
• Suite signage.
• Physical move of non-furniture or equipment (files, printers, etc.).

Descriptions and estimated costs for most of the items above are provided in a companion article to this one, "How Much Does it Cost to Build Out office Space?" The article covers costs associated with architecture, engineering and construction, the items that will make up most of your upfront expenses. It also provides insights and estimated costs for voice and data cabling, security, audio visual systems, furniture, moving and signage.

Below, Weiss focuses on three of the remaining expense items for which tenants need to budget (the first months rent, a security deposit and legal fees), and shares her insights regarding the latitude and negotiating room that tenants may have with each.

First-Month's Rent

The first month's rent is paid upon execution of the lease, so you need to have that sum on hand, even if you have successfully negotiated for a period of free rent. "That upfront payment is [often] an advanced rent payment," Weiss said. "Let's say I negotiate a five-year lease and the first six months of rent are free. The first month's rent is paid at execution of the lease and it's applied to the seventh month," she explained.

Therefore, if a broker negotiates a significant number of months with free rent, the tenant must still have funds available for at least one month's rent when executing the lease.

Security Deposit

The security deposit is a standard request by landlords of all property types in addition to the first month's rent. It is held by landlords throughout the life of the lease in case of damage or default by a tenant. However, Weiss noted that the amount is negotiable, and it depends on the landlord's transaction costs, such as allowances toward renovation of the space, as well as the landlord's assessment of a tenant's financial wherewithal. "That's why when you're negotiating the terms of the deal, you have to submit financial statements so that the landlord can assess the risk in doing the deal and then establish a [reasonable amount for the] security deposit," Weiss said.

Additionally, she noted that security deposits vary significantly, ranging from zero to the equivalent of a year's worth of rent. "If you're working with a multinational company or a very well-established firm, you're going to be able to negotiate a much smaller security deposit," she said.

However, there is negotiating room for small tenants. She said that in some cases, the amount of the security deposit can be decreased throughout the life of the lease, "depending on how the tenant performs." For example, an agreement can be negotiated and memorialized in the lease to say that a tenant that has never been in default, has paid rent on time consistently over two or three years, has remained profitable and hasn't caused any issues in the building, can have some portion of the security deposit returned, while they are still in the building, rather than waiting until the lease expires.

Legal Fees for Lease Review and Negotiation

Legal fees vary greatly based on the complexity of the lease, as well as the market you are in. A full lease negotiation with a new landlord will require much more work than negotiating a renewal or expansion in an existing building. "If it's a shorter document, and there are fewer business terms to negotiate and legal terms to include and review, it will cost less," Weiss noted.

"For a straightforward office lease, the legal review could be somewhere between $3,000 and $8,000," she said. However, the complexity of a lease increases depending upon the process and scope of the construction, as well as the number of options and other terms included in the lease.

"Generally, the larger the transaction [i.e., the more square feet a tenant leases and the longer the length of the lease], the more leverage the tenant has in lease negotiations and the more intensely they will want to scrutinize the provisions. For these types of transactions, legal fees can be up to $25,000," said Weiss.

Scope of Construction or Renovation

"Costs also depend on whether there's a significant build out requirement, because a big part of a lease can be the work letter that outlines the construction process," Weiss said. The work letter is a statement in writing that includes details about the build out process, the allowances, engaging contractors, review times and more. It is usually attached as an exhibit to the lease and both the tenant and the landlord must sign it.

Options

Other elements that add to the complexity of a lease are the number of options to be negotiated and memorialized in the document. They can include options that cover a tenant's opportunity to expand or contract the amount of space they occupy in a building; the possibility of early termination and fees and dates associated with it; and renewal options that might lead to below-market rents or concession for the tenant. Options like these, as well as other terms of the lease, are highly customized to each transaction.

Negotiating

"It's also about the negotiation process because some lawyers are easier to negotiate with than others," said Weiss. "So, it could be that there are many conference calls, and many redrafts going back and forth, so that's just more hours," that translate into higher fees.

Lingering Issues

Issues that linger until the end of the negotiating process are different with every transaction. "It could be anything from the build out, to the security deposit, to insurance issues," Weiss noted. "It can be, almost any aspect of the lease, not so much the business terms because those are pre-negotiated and included in the Letter of Intent. But sometimes there are legal points that relate to language, so the lawyers go back and forth until those are agreed upon.

"But, I've rarely seen a deal where it's just been two or three [iterations] back and forth," she said. "It's usually at least five, sometimes 10; sometimes in the final throes of negotiations, it's not about documents flying back and forth anymore, [but rather] about very specific … tough issues that have to be resolved by phone or in a meeting."

Consider a Tenant Rep Broker

"Many go into the process focusing on the monthly rent and not giving consideration to transaction costs and how knowledge of these can assist in the negotiation process," she said. While tenants are certainly able to go it alone, as a long-time professional, Weiss understandably advocates for engaging a tenant rep. She concluded that, "The complexity of the process is best managed by a tenant representative who can customize the budget for a tenant's specific project and provide recommendations on vendors to make the costs competitive and therefore more affordable [for the tenant]."

This article was updated on 12/13/2024