Due to Nevada’s vibrant economy and immense growth, the state’s commercial tenant improvements industry is booming. High construction and land costs, however, are greatly affecting the market and its key players. A look at the industry reveals several related trends.
The Nuts and Bolts
Commercial tenant improvements, often referred to as TIs, are modifications made to a leased or purchased space for the tenant or buyer. They include doors, carpeting, paint, walls, restrooms, lighting and much more. Frequently, TIs are critical to whether or not a deal on a piece of property is made. “When a company takes a space, they have a specific use in mind,” said Paul Perkins, SIOR, CCIM, senior vice president of industrial properties for NAI Alliance, a Reno commercial brokerage and property management company. “If the space does not work for them in all respects, they’re not going to take it.”
Oftentimes deals involve negotiated tradeoffs. For example, if a space offers a particular company all the right amenities, but it lacks offices, the addition of offices will be negotiated. “Every deal is different,” Perkins added. “Your landlords’ personalities, your tenants’ personalities, the tenant improvement buildout – everything is different in every deal.” The negotiated tenant improvements are detailed in a work letter, a document attached to the lease. “It can get as detailed as including the texture on the walls,” says Lucinda Stanley, CCIM, CPM, vice-president of development, SAXA Inc., a commercial development company with offices in Las Vegas.
Tenants or buyers are ultimately responsible for the cost of tenant improvements. However, with leased property, the landlord may provide an allowance that pays for some, or all of them. In those cases, the tenant funds the remainder. The financial arrangement can get worked out in a number of ways, which often depends upon the tenant’s credit worthiness, Perkins said.
The landlord may pay for all TIs but insist upon a 10-year lease. When the landlord and tenant share the TI expense, the landlord may request the tenant pay the tenant’s portion up front, said Chuck Witters, SIOR, senior vice president at Lee & Associates, a Las Vegas-based commercial real estate brokerage. The landlord may allow the tenant to pay half at the outset and the rest over the lease term, with interest added for the amortized share. Or, if the tenant has strong financials, the landlord may amortize the entire amount over the lease term, along with an 8 percent to 12 percent interest rate.
“You might get a $30 per square foot allowance, but have to move into a gray shell and buy everything, or you might get a $15 per square foot allowance and get painted walls, a ceiling, slab and a bathroom,” said Jeff Manning, II, founder and principal, Action Building Group, a commercial construction company in Las Vegas.
When a landlord contributes to the TI costs, the landlord usually wants to control how the money is spent and ensure the improvements are done to code, Stanley said. In the case of a purchase, however, the developer only oversees a few issues, such as whether and how anything will be attached to the shell. Otherwise, buyers may do whatever they wish inside.
Impact of High Costs
Construction costs, and therefore tenant improvement costs, already high, are continuing to increase throughout the Silver State. “I can remember when concrete was $45 a yard in the [Las Vegas] Valley and now it’s $105 a yard,” Manning said. “It’s sticker shock for a lot of folks.” Consequently, the costs of doing tenant improvements also are rising. To compensate, TI allowances todayare higher. In 1993, they were about $20 to $25 per square foot, Witters said. The price per square foot gradually rose to $30 and now it ranges from $35 to $50.
Despite growing allowances, the actual costs outlined in bids frequently exceed the allotted amounts. “My experience has been, that in eight out of 10 of my deals, we’d get the bids and be over the TI allowance,” Witters said. “Now that happens on 10 out of 10 of my deals.” Witters finds that national companies most often pay the cost above the allowance, but local Southern Nevada businesses rarely do. Earlier this year, he brokered a deal with a large insurance corporation in which the TI allowance was $40 per square foot. The cost came back at $93 per square foot. The corporation paid the difference for 8,300 square feet ($439,900). “They wanted to build it per their corporate standards so they were willing to pay for that,” he said.
The lease rates of commercial spaces are greater, too, so landlords can recoup monies they paid out for TIs. In Southern Nevada, lease rates have increased over the last two-year period about 30 cents per square foot per month, Witters said. The high costs of TIs are driving some companies to forego new and opt for second, third- or fourth-generation space. Consequently, a surge in retrofitting of older buildings is taking place. The increased demand in these older buildings is driving up their lease rates, too. “It’s not uncommon at all, and we’re going to see more of it,” Perkins said.
If a building meets the current Americans for Disabilities Act code, retrofitting may involve only recarpeting, remodeling and perhaps moving a few walls – all for about $10 to $15 per square foot, Stanley said. If it doesn’t meet code, the landlord and tenant have to bring a percentage of it up to ADA code and may get hit with various remodeling expenses based on the type of business going in.
The high costs of carrying out TIs are affecting lease lengths. Witters said that most often, landlords require a five-year minimum lease because they need that time to amortize the cost of the tenant improvements. Because tenants typically want only a three-year lease on second- or greater-generation space, landlords typically spend less money on those TIs.
Key Players’ Responses
All players involved in tenant improvements, from the contractor to the tenant, are looking at ways to save or get the best value for their money. “I think tenants are trying to be efficient with their space planning,” said Par Tolles, managing director of CB Richard Ellis/Trammell Crow Co. for Northern Nevada, a commercial real estate company. “They’re looking at any way they can keep down the costs.”
This value engineering analysis oftentimes involves tenants determining what TIs they must have and what TIs they want. Some ways tenants and landlords are cutting TI costs are by reducing or eliminating built-in cabinets, pony walls (4- to 6-foot-high divider walls) and any unnecessary frills, such as sidelights on doors and windows next to doors.
The trend is away from multiple coffee stations and back to one central break room, to avoid the costs of multiple sinks. “Nobody’s doing their own personal bathroom,” said Amanda Marro, principal in charge of developer services at Parker Scaggiari, an interior design, architecture and graphics firm in Las Vegas.
Tenants are spending more money on the highly visible, public places, typically lobbies and conference rooms, while keeping the remainder basic, said Pete Blakely, president, BJG_Architecture + Engineering, a Reno engineering and architecture company. As far as interiors and finishes, color schemes that will last 10 or more years are popular, Marro said. Tenants are moving away from a lot of color – such as salmon pink – and toward the use of neutral shades that won’t go out of style.
Another strategy is to buildout a space using modular furniture, even floor-to-ceiling, movable walls with doors to create flexible office space rather than immovable walls. “They can use that allowance in their furniture budget vs. construction budget,” Marro said. “If they have more of a budget for furniture, it’s a good option for people.” This open office setup might include a couple of traditional offices but the rest is comprised of cubicles and furniture. If a company with modular furniture moves to another space, it can take it with them. “It’s pricier on the front end, but it gives them even more flexibility with their space,” Stanley said.
“Some firms are generating extra income through subleasing,” Marro added. They may purchase a building in a business park, demarcate a space for their operations, then sublease to other tenants.
Developers are building larger buildings because of economies of scale – about 500,000 to 600,000 square feet in size – and then dividing them for multiple tenants. At least two that size have been built in Northern Nevada’s Tahoe Reno Industrial Center.
“I can remember when a 300,000-square-foot spec building was huge,” Perkins said.
Incorporating Green Elements
Some tenants and buyers are requesting features that are Leadership in Energy and Environmental Design (LEED)-certified by the U.S. Green Building Council. These include environmentally-friendly, energy-efficient elements, such as: low-volatile organic compounds (or low-VOC) paint and carpet; upgraded T5 and T7 lighting (narrow diameter fluorescent light tube – T8 lighting is a 1-inch fluorescent light tube); recycled materials such as carpeting; nonrefrigerant-based cooling systems; white reflective batt ceiling insulation; motion-detecting lights; and special parking for hybrids. Green, occupant-friendly components include greater use of daylight, elimination of designated, indoor smoking areas and more.
Fewer companies want to go all out green with LEED-certified buildings. Some developers have green initiatives. Reno-based DP Partners, for example, is committed to using and exploring energy-efficient resources and environmentally-friendly options. “It costs between 2 percent and 5 percent more up front to do green projects, but you’re going to recover that over the period of time you’re in the building,” Manning said. In addition, other savings are afforded in tax credits for green building. “For some of the larger projects, the tax incentives can be quite large,” said Elliott Goodwin, engineer, project manager and LEED-accredited professional with BJG_Architecture + Engineering.
For the LEED gold-level certification of its 171,000-square-foot distribution center expansion, Patagonia, in Reno, received real property tax abatements from the Nevada Commission on Economic Development of 50 percent over the next 10 years. The company also received $25,000 through Sierra Pacific Power Co.’s Sure Bet, an incentive program designed to facilitate the implementation of cost-effective, energy-efficiency improvements in businesses.
In an effort to please workers, more and more companies are incorporating a higher level of design into their spaces, Blakely said. Instead of Navaho white, they’re incorporating texture and colors. Rather than install a white and gray patterned vinyl composition tile flooring, they may opt to embellish it with some colored tiles. Other design twists Blakely’s seen are glass panels in modular furniture and modular floor systems filled with colored rock. “Employee satisfaction is what’s driving the willingness to put a little more fun into it,” he added.
Perkins has noticed a similar trend in industrial buildings. Rather than unfinished walls, he’s seeing more finished walls painted white. Staging area distance for trucks is greater, now 150 feet vs. the previous 120 feet. Clear height also has increased to 30 feet from 24 feet, to add another level of racking.
Other TI Industry Trends
Build-outs today are taking longer than ever before due to lengthier permit processes.
“We used to do it across the counter,” said Lou Primak, area manager, PENTA Building Group Inc., a commercial general contractor in Las Vegas and Reno. “Now it’s taking anywhere from four to six weeks to get a permit.”
Consequently, contractors face pressure to get the work done quickly. “We used to quote 75 to 90 days from lease execution to get the permits and build-out the TIs,” Witters said. “Now we’re quoting 120 to 150 days just to be safe. Tenants who can’t wait are looking at second- and third-generation space.”
Limited resources, particularly qualified workers, further complicate the situation.”We really have to find ways of making our schedules more efficient and getting the tenants in as soon as possible,” Primak said. “The constrained resources just make it tougher.”
“As a result, more and more spaces are being built on a speculative basis,” Stanley said. The trend is to build-out a space, making it as generic and functional as possible. The tenant and buyer can then go in and add more offices if they want. The use of modular furniture is popular in these instances. “It shortens that six-month period to where they can take immediate occupancy,” Stanley added.
Because the entire tenant improvements process is rather complex, some builders have begun offering more services than simply erecting the walls and doors. Manning’s company, Action Building Group, is one. Along with construction, his firm handles design, signage, telecom, financing and construction. “We go from a list of their needs to a set of their keys,” Manning said.
What to Expect
Industry experts predict more of the same. Over the next five years, TI costs, TI allowances and lease rates will continue climbing, Witter predicted. Blakely anticipated that tenants, particularly the smaller, less credit-worthy tenants, are going to be expected to pay larger percentages of TI costs.
More and more tenants and buyers will choose to incorporate LEED-certified features, such as T5 and T7 lighting, and many of these features will likely become standard. “Also along green lines, in the future, we’ll see deconstruction, efforts to remove and recycle components out of old buildings slated for demolition,” Manning said.
