How to protect your business when making leasehold improvements
5-minute read
If you’re not careful, renovating a newly leased commercial real estate space can be a task fraught with headaches. Your landlord, for example, may nix some of the renovations you need to run your business. Unexpected cost overruns or delays can mess up your budget or disrupt operations. Your bank may turn you down when you need financing.
The good news is that a little forethought can help ensure your renovations go smoothly. “Renovating a leased space can be expensive, so it’s important to protect the value of your investment,” says BDC Corporate Financing Director Reese Jenkins. “With the right approach, you can get your landlord on board and significantly reduce your costs.”
Here are eight crucial steps Jenkins says businesses should follow when doing leasehold improvements (sometimes known as tenant improvements).
1. Plan effectively
To minimize the risk of headaches, figure out your company’s space needs in detail before you lease a commercial space, if you can. Think about not just current needs, but also future growth. Consider asking an operational efficiency expert to determine whether your workspace can be rearranged to take up less square footage. Then, prepare a solid budget for your space needs.
2. Discuss plans with the landlord
Lease negotiations are the time to discuss renovation plans with the landlord. Make sure the landlord consents to your plans before signing, and that the lease allows both your currently planned work and future renovations. Renovation plans are often included as an addendum to the lease.
“It’s good to get an idea of the landlord’s openness to your renovation plans,” says Jenkins. “They may have a problem with anything that could reduce the value of the building.”
You should also make sure the building can structurally support your renovations and any machinery you want to install.
Tip: In case of disagreement with the landlord over future work, you can seek a lease clause stating that such conflicts should go to mediation before legal action is pursued.
3. Protect your assets
Also during lease negotiations, make sure the lease or addendum to the lease clearly states which assets you can take with you if you move out of the building and which are considered part of the building.
Typically, you’re only allowed to take easily removable items, such as furniture, inventory and computers (sometimes known as trade fixtures). All assets that are fixed or attached to the premises are generally considered part of the building and must stay, unless an exclusion is made in the lease. These assets can include machinery, flooring and built-in shelving.
Be sure your lease explicitly clarifies the status of all assets you may want to remove if you leave. Your bank may also require a clause of this nature if it finances any of your machinery.
4. Seek tenant inducements
Most landlords know that quality tenants can help improve a commercial real estate property’s value, so don’t hesitate to ask the landlord to help you pay for renovation costs. The landlord may offer cash to cover some of the costs, called a tenant improvement allowance—usually a certain amount of money per square foot of rented space. The landlord may also offer several months rent free or at a discounted rate as a tenant inducement. This, too, can offset some of the renovation expenses. Note that the landlord’s willingness to offer inducements may depend on factors such as their eagerness to fill the space; the building’s vacancy rate, location and age; and your value as a tenant.
Yet another option is for the landlord to manage and pay for the work you want. Such changes are known as turnkey improvements or turnkey buildouts.
5. Get the right level of financing
Before signing the lease, meet with your banker to discuss your commercial real estate financing needs, in light of the improvements and renovations you’re considering. Make sure you’re getting the right level of financing and exploring all your financing options. For example, you may want to seek a term loan, a working capital loan and/or a line of credit to help pay for renovations and ease strain on your cash flow.
6. Engage skilled experts
Get quotes for the renovations from reputable contractors who have done similar work and have a track record of finishing jobs on time. Be sure to check their references. With your contractor, assess your renovation needs and obtain any permits necessary, well before moving day.
Also, ask a reputable commercial lawyer who specializes in leases to review your lease. Your lawyer or a realtor should also confirm that municipal bylaws allow your business to operate in the building.
7. Ease the transition
Work with your employees to create a timeline for doing renovations and moving assets in a way that minimizes upheaval for your business.
Renovations often go over budget and past deadline, so help ease disruption by setting aside a contingency fund and buffer room in your timeline.
8. Monitor the work
Keep a close eye on renovations to see whether they’re on time and within your budget, so you can adjust your plans right away in case of hiccups. “It’s very rare to have a project whose budget is dead-on for every item,” Jenkins says. “Be prepared to drop or put off some of the work if you experience overruns or delays.”