A turnkey buildout is a situation where the landlord’s responsible for completing all the necessary improvements and modifications to the leased space before the lease commencement date. The space is delivered in a finished, ready-to-use condition, or "turnkey" state. In this arrangement, the landlord manages and oversees the entire improvement process, such as design, permitting, construction, and inspection. Landlords are typically more inclined to offer turnkey buildouts for shell spaces (unfinished interior spaces) because it constitutes as a long-term capital improvement, increasing the overall value of the asset. As outlined below, a turnkey buildout serves the tenant's interests by delivering a space that meets their specifications within a predefined budget, while requiring minimal involvement from the tenant's side.
Pros for tenants:
No Upfront Costs:
In a turnkey buildout, the landlord covers all the costs for the agreed upon improvements. This spares the tenant from having to distribute any upfront capital towards any changes made to the space.
Since the landlord manages the entire construction process, the tenant can focus on their core business operations. The landlords’ responsible for coordinating all vendors, obtaining necessary permits, as well as making sure the build out is delivered per the agreed upon scope.
Landlord Assumes All the Risk:
A significant benefit for tenants in this context is that the landlord carries all the risk. Should the real expenses of the buildout surpass the landlord's initial budget, the landlord would bear these potentially substantial extra costs. Nonetheless, current market uncertainties, including variable materials costs, prolonged delivery times, and workforce shortages, have made landlords more circumspect about committing to a turnkey buildout agreement.
Cons for tenants:
Obtaining a Certificate of Occupancy
Longer Lease Term:
With the landlord making a significant investment in the space, including construction, labor, materials, architectural fees, and any unexpected costs due to delays, materials, supply, etc. In return for that capital investment by the landlord, the longer-term lease gives more stability to the landlord along with making the asset more attractive for potential investors, highlighting the long-term income potential and improved state of the premises.
This allows the landlord the ability to amortize the cost of the buildout over a longer period, allowing the landlord to stay competitive from a rental rate standpoint.
Tenants’ Credit Highly Scrutinized
Landlord will want to carefully review financial statements, such as P&L statements, credit history, and balance sheets dating back 2-3 years. The more money a landlord puts into a deal, the more scrutinized a tenant’s financials will be, as landlords aim to reduce any potential risks. There might be instances where they require a tenant sign a personal guaranty. WRA would advise our clients to avoid this arrangement. It gives the landlord the ability to seize personal assets if the company cannot fulfill its lease commitments.
A turnkey buildout is generally the optimal solution for a tenant, as it can significantly save time, resources, and avoid unnecessary stress. However, unprecedented rises in construction costs in recent years, attributed to surging material and labor prices, have amplified the financial risks tied to these projects. Consequently, landlords are exercising more caution and reluctance in committing to complete turnkey buildouts, given the unforeseeable fluctuations in these increasing costs.