Often while looking for commercial spaces, the properties you are interested will require some renovations. Commercial properties may require anything from some basic updates to a full-on makeover depending on the situation.
What is a commercial buildout?
Commercial buildouts are those renovations needed to ensure the property is ready for a new tenant to move in and begin doing business. Buildouts can be done to improve function or even add personality and charm. They are not necessary in every case.
As you tour properties and consider new spaces, think about your design requirements to determine how much build-out you will want. Depending on your business, here are some questions to consider:
· How many offices do you need?
· What kind of open space?
· Will there be a kitchen?
· Do you need a waiting room?
· What kind of storage will you need? Closets?
Think these things over so you have an idea of what you want before starting your search.
You should also consider what amount of renovation you want to do. If you pick an office space that is already suited for your business, chances are you may not need to do much. However, if you want to occupy a new property or open a new restaurant, you may have to start from scratch and design the space if it is just empty.
Are Commercial Buildouts worth the trouble?
If you can find a space that already is suited for move-in, you may be wondering why you should even bother with a space that needs renovations. The answer is that build-outs are part of cost-benefit analysis.
If you find the perfect location but the space is not quite functional, you need to consider whether you want to spend the money for the build-out or choose a different location, even if it’s less than perfect location-wise.
If you are searching in a hot market, the demand is likely very high and good spaces will be leased quickly and snatched off the market before you get a chance. In these instances, you may have to rely on build-outs to modify spaces to fit your business.
Who Pays for Build outs?
The answer depends! But the key is negotiation. During the negotiation stage, you will be discussing property modifications to prepare the lease and make changes. During this time, the landlord may agree to pay for the buildouts, the cost may be split, or the responsibility might fall on to the tenant.
Negotiation is very important and here it all depends on what you negotiate for.
There are couple different types of buildouts as well:
1. Turnkey Buildouts
Landlords understand that not every business will be able to function in their property, but not every tenant will want to pay to improve a rental space. In this case, the landlord might be willing to pay for the improvements.
Turnkey buildouts are convenient because it saves you some money and effort, however, landlords may use cheaper labor and materials than you would choose for yourself.
Make sure you address this factor during negotiations. Specify in the contract what type of quality you want or if you have a specific contractor in mind.
2. Tenant-Controlled buildouts
If you want to be responsible for renovations to ensure quality and have more control, you might just want to pay. Improvements still need to be discussed with the landlord and agreed upon, but you can elect to be in charge of the changes. You can choose the contractor and hire whoever you want. This way you will have a say over any decisions that need to be made as well.
With this type of buildout, you can negotiate a tenant improvement allowance from your landlord.
Tenant improvements allowances are given in dollars per square foot. Keep track of expenses for buildouts and landlords may reimburse your funds after the improvements are completed.
Sometimes negotiations may conclude a shared cost between tenants and landlords. A landlord can provide a certain amount of money to replace carpets, and then if the tenant wants to really upgrade the quality of the carpets and buy some expensive ones, they can cover that difference.
Tax Implications of the Buildout Payment:
1. Landlord Pays for the Improvements:
When the landlord pays for the renovation, then the landlord owns the improvements. As for tax implications, the landlord will record the improvements as a fixed asset and then depreciate the value of the improvements over a specific period. Length of the depreciation depends on the type of property. If it is residential, the depreciation period is 27.5 years, if it is commercial then it is 39 years. If the new tenant does not want to use the property as is, then the buildout will be destroyed and the landlord will have to write off the remaining undepreciated balance of the asset.
2. Tenant Pays for The Improvements:
If the tenants pay for the improvements, then the tenant owns the improvements. In this case, the tenant will amortize the money they spent on the improvements over the period of the rental term. If the amortization period is longer than the rental period, then the tenant will write off the remaining amount at the end of his/her lease.
3. Pass-through Arrangement
If Landlord gives tenant money or free rent to do improvements, tenants will declare the deductions from rent or money received as income. For the landlord, the rent will be treated as a cash payment but the cost of the improvements will be depreciated.
Having all these different implications in mind, make sure to use a Real Estate Professional who has the experience in negotiating the deal that makes sense for your business plans.