Striking a Balance on the Build-Out

As rents rise across the country, CFOs are negotiating more aggressively to save money on the cost of outfitting new office space.

Thanks to a resurgence in mergers and acquisitions, 2005 was a very good year for Lane, Berry & Co. So good, in fact, that the small, scrappy investment-banking firm now faces one of the biggest challenges since its founding four years ago. Lane, Berry is racing to expand by adding 30,000 square feet of office space in New York and Denver while also moving to new, larger offices in Boston. Charting a path through these complex real-estate negotiations has fallen squarely on the shoulders of the firm’s CFO, Karen Vernamonti.

Among other things, Vernamonti has had to untangle a knot of issues that included not only the cost of rent but also the cost of outfitting the new space to suit the firm’s image-conscious bankers. Eager to move in quickly, she opted to pay a slightly higher rent on the space in return for an agreement by the landlord to build out the new offices to suit the needs of the firm. “Our build-out allowance is very important to us because it is, effectively, an interest-free loan from the landlord,” Vernamonti says. “We fought very hard for these dollars because, as a small, growing company, we want to preserve our cash flow.”

Build-out allowances cover the cost of such things as design, new carpeting, interior walls, lighting, mechanical systems, and other improvements the tenant needs to conduct business.

New Sophistication

Negotiating the build-out of office space is a matter of increasing importance these days. After years of stagnation, rents are beginning to rise in many cities across the United States. Vacancy rates are shrinking, most notably in New York; Washington, D.C.; and San Francisco. That means office space — already one of the top three fixed costs for many businesses — is likely to get even pricier this year.

Funding a build-out raises important tax and cash-flow considerations that could have serious long-term implications for tenants. “CFOs are getting much more sophisticated about these issues,” says James A. Schwartz, senior vice president of Equis Corp., a real-estate services firm based in Chicago. “They have to be nowadays because there are significant dollars involved in corporate real estate.”

Renting office space is an increasingly complicated transaction. A lease contract may be several hundred pages of dense legalese covering every conceivable contingency, from subleasing to repairs to such minute details as the brand of light switch used in a conference room.

“Of more than a dozen nonrent variables,” says Marisa Manley, president of Commercial Tenant Real Estate Representation Ltd. in New York, which represents clients in negotiations with landlords, “the build-out is one of the most critical. New tenants are going to be spending a lot of money in a short period of time, typically 12 or so weeks, and so the decisions they make about funding that build-out should be made with great care.”

Unfortunately, Manley adds, “CFOs’ eyes glaze over when they review these contracts.” Some are under extraordinary pressure to cut a deal quickly because the firm wants to take advantage of growth opportunities. So leases — and, ultimately, the cost of real estate — sometimes don’t get the attention to detail they require, she says. Manley urges caution for all of her clients. “Real estate is not a level playing field,” she says. “Landlords are experts in the details; tenants typically are not.”

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