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.

Changes in Tax Law

As an example, says Manley, a tenant leasing 50,000 square feet of office space in New York may get a build-out allowance as high as $50 per square foot. If the tenant opts to take the allowance as cash, she says, that’s a payment of $2.5 million, which, for those clients with a federal corporate-income-tax rate of 35 percent, means a tax bill of $875,000. Federal taxes could be reduced by negotiating reduced rent or a turnkey build-out of the space.

Experts who represent businesses in lease negotiations advise their clients to take a hard look at all the numbers. “We advise our clients to request two quotes from a prospective landlord: one with the build-out allowance and one without,” says Johnson Controls’s Howell. “Then, we can evaluate the cost of borrowing from the landlord, and consider the offer in light of several factors, including tax considerations and the tenant’s cost of capital.” Landlords, he adds, may not be the most efficient lenders, so he often urges clients to consider different approaches to funding — and thus controlling — the build-out themselves.

To maximize tax savings on a build-out, some are turning to an IRS-approved tax method called cost segregation, which allows them to depreciate certain building components over a shorter period of time. Tax law allows some components such as carpeting, wall coverings, millwork, land improvements, and parking lots to be depreciated over 5, 7, or 15 years. There are 130 categories of property that qualify for depreciation over shorter recovery times. In some instances, 25 percent or more of the value of a build-out can be depreciated more quickly, thus yielding substantial tax savings for a tenant.

Larry Brewster, director of federal tax reduction with O’Connor & Associates in Houston, says more companies are moving to reduce federal taxes by depreciating certain items on a more rapid schedule. “CFOs’ biggest concern is, ‘Will this trigger an audit?’” Brewster says. “The IRS actually views this as the correct way for companies to depreciate the cost of build-out.”

P.B. Gray is a business writer based in suburban Boston.

Not-So-Wide-Open Spaces
Vacancy rates are shrinking in the top 10 office markets in the U.S.
Q3 2005
Vacancy Rate in Selected Markets
% Change
from Q3 2004
1. Dallas/Ft. Worth 25.8% 2%
2. Atlanta 21.3 2.9
3. Houston 20.3 1.5
4. Chicago 19 1.3
5. Los Angeles 15 2.3
6. San Francisco 14.8 4.5
7. South Florida 13.7 2.6
8. Orange County, CA 11.9 4.9
9. New York 10 0.1
10. Washington, D.C. 7% 0.4%
Source: Studley Office Space Data Report

Building the Cube Farm

Leasing experts who negotiate build-outs for business clients have some tips for those looking to lease office space in 2006.

Flexibility is key. Tenants should ensure that plans for design of their new space will accommodate the company’s growth or necessary cutbacks. Make sure subleasing is an option.

Budget enough time for the design and construction of the new space. Review architects’ and builders’ plans carefully. Make changes early — before nails are pounded into walls. Paying contractors overtime can inflate a budget dramatically.

Review all details of the build-out. Demand pricing for all items — even the light switches. A fancy light switch in every office and conference room can increase the electrical budget by 20 percent.

Discuss

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