The Intersection of Construction and a Proficient Real Estate Lease

By Scott Hamele

Kansas City, MO – The success of ground-up construction or a commercial interior tenant improvement project is greatly enhanced by a skillfully written commercial real estate lease. Several sources provide the contents of a commercial lease and may include real estate brokers, attorneys, owners, tenants, general contractors, architectural and engineering firms, developers, property managers and bankers. Because the lease is composed of critical information from almost a dozen parties, it affects the construction project’s duration, value and quality—and its likelihood of success.

According to Costar Group’s Year-End Office Report, the office market in Kansas City saw a positive net absorption of over 1.5 million square feet in 2015. We predict that Kansas City will continue to see positive net absorption in the Kansas City area in 2016 for several reasons, but primarily because of the lack of new speculative construction in the market. About 1.6 million square feet of office space is currently under construction and only 10 percent of that space is available to lease—all the more reason to expect continued growth and increase your knowledge of a proficient lease.

Minimizing risk

It’s important to identify the right questions to ask regarding tenant finish projects. While understanding the costs of the improvements is important, there are several other key factors that can help minimize risks for both tenants and owners. Asking questions up front helps convey the intent of the lease and ultimately the success for the owner and tenant.

Professionals who have Certified Commercial Investment Member (CCIM) designations know what questions to ask and have the tools to analyze and compare other buildings in the market to recommend a fair lease rate and construction allowance. The following are key areas of a lease and information about how they can affect the design and construction of a project:

Construction allowance

The construction allowance is how much money the owner is contributing towards improvements and is directly proportional to the lease rate and length of term of the lease. Typically, the lower the lease rate, the smaller the allowance and vice versa. Consequently, the higher the landlord’s construction allowance, the less the tenant will need to invest into their space. It is important to know if the allowance is based on usable versus rentable square feet.

Scope of work

Understanding where the construction allowance begins and documenting it in the lease can help alleviate problems down the line. Every transaction has different conditions by which you begin a construction project. In some instances the term “white box” may be part of a lease and will detail a space that will be turned over to a tenant that will include suitable restroom facilities, finished acoustical ceilings, adequate lighting, power and heating as well as proper life safety equipment. The definition of the scope of work can come from several possible sources, such as the architect, owner or general contractor. However, it is ultimately up to the leasing agents, property managers and attorneys to ensure a scope of work that the landlord and tenant agree on, is fair to all parties and relative to the basis of general contractor pricing.

Substantial completion

In most cases, the owner is responsible to turn over a building or space on a specific date that is sufficient for the tenant to operate their business. However, this date can be a bit ambiguous unless properly defined in the lease document. The space is deemed “substantially complete” when the contractor has obtained approval from the governmental jurisdiction codes officials (usually city officials) for such occupancy by way of “approval to occupy” certificate or a “temporary certificate of occupancy .” Only then can the tenant legally occupy the space. This does not affect the quality of the occupancy and allows the tenant access to the space and full use of the rentable premises for the operating of their business.
Clearly defining the construction allowance, scope of work and occupancy date in a lease document are just a few things that can help minimize the challenges that will be associated with moving into a new commercial space. Working with a professional with CCIM designation and a reputable contractor can assist in the delivery of a real estate transaction that is both successful and sustainable for all parties.

This article can be found in this weeks edition of the Kansas City Business Journal.

Co-Authored by:

Scott Hamele is president of Construction DesignWorks, Inc., in Shawnee, Kan. He is a leading commercial design-build general contractor, specializing in interior tenant improvements in the Kansas City area. Hamele has blended his engineering, architectural and real estate investment background to provide unique, creative and solution-based construction services to clients. He can be reached at Scott@ConstructionDesignWorks.com or 913-745-4727.

Adam P. Abrams, CCIM, is a commercial real estate expert who focuses on sales and leasing of office properties, tenant representation and real estate investment advisory services with RED Brokerage, LLC. He serves as a member of the Public Works Committee for the City of Leawood, Kan., and the Johnson County Advisory Board for the Metropolitan Organization to Counter Sexual Assault. Abrams also is an alumnus of the Kansas City Chamber of Commerce Centurions Leadership Program. He can be reached at aabrams@redbrokerage.com or 816-876-2544