Negotiating a Commercial Tenant’s Initial Buildout: What You Need to Know

By Steven Milstein

When moving into a new space, a commercial tenant will often want to alter the space to meet their needs. For example, a grocery store will need to change the layout of a space that was previously leased to an accounting firm. Alternatively, a commercial tenant may move into a brand-new building in which the leased premises is a “white-box.” Regardless of why a tenant needs an “initial buildout,” the initial buildout is an extremely common, and often necessary, measure for a commercial tenant.

There are many considerations to take into account as it relates to the initial buildout, which often leads to negotiated buildout lease provisions. A landlord may want to do the buildout so that they can retain control of the quality of work, materials used, and speed of the buildout, while a tenant would want to make sure that the buildout is done exactly to their needs and/or liking. As a compromise, some leases require the landlord to do a portion of the initial buildout with the tenant being responsible for the remaining portion.

When a landlord and tenant agree to split some of the buildout responsibilities, each party’s respective obligations should be laid out in a “work letter.” In addition to each party’s obligations, the work letter also sets forth, among other things, (i) a budget for the buildout, (ii) a timeline for the work to be done, and (iii) the specific third parties that will be working on the buildout. It is important for the lease to account for the work letter and provide specific remedies in the event a party does not fulfill its respective obligations thereunder.

The lease should also contain ironed-out provisions with regards to insurance requirements, as well as various indemnifications with respect to the buildout. A landlord should ensure that any work being done on the premises is properly insured. Additionally, each party should be properly protected, through thoroughly drafted indemnification provisions, in the event any claim arises due to the buildout.

Landlords and tenants will also negotiate provisions regarding who is responsible to pay for the initial buildout. If a landlord does the buildout at their own expense, they may seek to account for such expense in the tenant’s monthly rent payments. If the tenant is the party in charge of the buildout, they will often negotiate for a “tenant allowance;” a tenant allowance is essentially a set sum of money that the landlord “gives” to the tenant for the buildout. If the tenant needs more money, it will need to come out of their own pocket. Landlords can give the tenant allowance by periodically giving the tenant a sum of money (up to a fixed amount) once certain buildout thresholds are met (the buildout thresholds should be clearly laid out in the work letter). Alternatively, the tenant allowance can be given in the form of a rent credit. Landlords should always make sure to know the state of the leasing market; if other landlords in the same vicinity are offering certain “buildout incentives,” it would be wise to, at the very least, match such market incentive.

When it comes to a restaurant tenant, the initial buildout is even more important. Aside for restaurant-specific equipment and layouts that differ from other commercial tenants, restaurants are subject to the Americans with Disabilities Act of 1990 (the “ADA”). The ADA requires a restaurant to have reasonable accommodations for patrons with disabilities. The landlord and tenant will have to decide which party is responsible to make a non-compliant space ADA compliant. On the one hand, the tenant’s use creates the need for ADA compliance, but on the other hand, it is the landlord’s building, and the landlord will retain the benefit of having an ADA compliant space once the restaurant’s lease term ends. Additionally, if a lawsuit if ever brought for ADA violations, the landlord and the tenant will be named as defendants since both parties are responsible for ADA compliance. In practice, most leases provide for landlord indemnification as to these violations, including legal fees.  Accordingly, if a tenant knows that ADA compliance will require modification of the premises, the tenant should account for this expense in their negotiations with the landlord, and it is in the landlord’s interest to ensure compliance is achieved before the premises becomes as active place of public accommodation.

As you can see, the buildout provision in a lease should not be overlooked. The ramifications for not thoroughly understanding a tenant’s needs can be very costly and can cause a tenant to go out of business – so it is important to make sure to have proper representation when negotiating your lease. For more information on commercial space buildouts, or for help on your next lease agreement, reach out to the knowledgeable real estate attorneys here at KI Legal.

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