By Joseph Pomerenke
Industrial vacancy rates in the Metropolitan Chicago Area have continued to decline through the 1st quarter of 2011 to nearly 11 percent, yet many developers and institutional owners maintain portfolios with a considerable amount of available square footage for lease. Although net absorption is rising in most submarkets, the competition is still high, which leaves landlords strategizing for ways to differentiate their assets from the competition. One way many of our clients have responded is by making speculative improvements to their buildings in an attempt to “make ready” their assets in order to attract new tenants. We are regularly asked by listing brokers and building owners to recommend and budget basic improvements that can be made to their buildings to make them more attractive to prospects. When exploring this question further, we have uncovered some of the most cost effective speculative improvements that can lead to the highest return on investment for landlords.
Landlords view tenant improvement budgets as a percent of annual rent. The question becomes; what level of tenant improvements will be sufficient to attract new tenants to a space? The goal of “make ready” improvements is often times to increase speed to market. Most requests for proposals ask for occupancy in as short as 60-90 days from execution of the lease. With the tenant improvement process often taking 4-6 months, it is critical to understand ways to achieve occupancy for tenants prior to completing all of the requested tenant improvements. Most municipalities require a few key improvements for tenants to occupy a building. These include completed and working restrooms, code compliant fire alarm systems, and emergency and exit lighting for egress from the space. While most buildings have working lighting and fire alarm systems, speculative buildings often do not have restrooms in place. Adding a restroom core to a speculative warehouse building can range in cost from $30,000-$70,000, but when complete, can offer tenants immediate occupancy in a building. This allows landlords to begin collecting rent immediately, rather than waiting for these improvements to be completed after a tenant is signed up. Take for example a 100,000-square-foot building with a $3/SF gross rent. The additional three months’ rent can offset the upfront cost of the restroom improvements by providing immediate occupancy to the building. Landlords that simply offering a competitive rent without the opportunity for immediate occupancy often miss out on tenant’s that would have otherwise decided to move into their space.
Other low cost warehouse improvements that have become common as a means of attracting new tenants include: painting of interior walls, replacing or upgrading warehouse lighting, and demolishing prior tenant improvements to open up a space and make it appear available for immediate occupancy. Painting of interior warehouse walls can cost as little as $0.20-$0.40/SF and can improve the appearance of existing lighting, and help with the appearance of existing warehouse space. Older buildings can appear new and compete with newer buildings offering higher rents. Lighting upgrades are almost always requested by prospective tenants. Landlords can stay ahead of this requirement by replacing lighting prior to new tenants. Providing new fluorescent lighting in warehouses typically costs around $0.50/SF.
Landlords should also consider speculatively improving the office space in their buildings. To be competitive, it is necessary for the office to appear modern, clean, and new if possible. Landlords can refresh the finishes in existing offices by replacing the carpet and painting existing walls for as little as $5-$7/SF. Other ways to improve the image of an office space might be to replace the ceilings, lighting, and/or doors and hardware. Often times, we recommend that landlords paint the grid or replace the tile only in lieu of completely replacing the ceiling which costs $1/SF in lieu of $2.50-3.00/SF. Similarly, landlords can replace the bulbs, ballasts, and lenses of existing light fixtures or use retrofit kits to make the lighting appear new without completely replacing the existing fixtures. Refurbishing the existing lighting can cost only $1/SF in lieu of $2.75/SF for providing all new lighting. One less intuitive reason that this may be a good strategy for landlords is that it can help control costs. If an existing office appears to be clean, new, and ready for immediate occupancy, tenants often do not request as many additional improvements from the landlord. Often, clients will choose to spend $8-$10/SF refreshing an existing office prior to a new tenant to prevent needing to offer a tenant $15-$25/SF for office improvements to attract the new lease.
In a multi-tenant building, the biggest unknown for prospective tenants is what their space will look like. If landlords market their buildings by simply stating that tenants will be provided with a build-out allowance for office space, there can be a disconnect with tenants who are not aware of what the allowance will buy them. One way for landlords to overcome this is by speculatively building one office space in the building to demonstrate to touring tenants what the finished product will be. This can also provide speed to market for the asset. We recommend that offices be built as “white box” spaces which include only perimeter walls, flooring, ceilings, and lighting designed as an open office area with only interior walls for restrooms. It is fast and cost effective for a tenant to build private offices, conference rooms, and break rooms within the footprint of the “white box” space after they commence the lease. These improvements can also be done with the tenant operating in the building. For example, the cost for 2,000 square feet of “white box” speculative office space can be between $30-$40/SF in lieu of $60-$70/SF for fully improved office space. By allowing the tenant to move in and commence the lease immediately, the initial months of rent payments can offset some the upfront costs incurred by landlords.
Those who take the initiative to complete speculative improvements prior to leasing have better success in leasing their assets. Determining what level investment in speculative improvements should be made is dependent on the desired speed to market, tenant expectations, and control of future costs. The strategy will be different for every landlord and each specific building, but it is clear that a little preparation by way of low costs speculative improvements can go a long way to leasing a building sooner.
Joseph Pomerenke is the Director of Business Development for ARCO/Murray National Construction Company. Joseph received his Bachelors of Civil Engineering from the University of Notre Dame and Masters of Architectural Engineering from Illinois Institute of Technology.