Imagine for a moment the following: Your career is going great. (For some, this alone may be too big a stretch, but stick with me because I am trying to make a point.) You’ve scrimped for years, and your family has now outgrown your home. Time to reward everyone by building a new house, one suited just for you, one that fits your family and lifestyle. You’ll be in the right part of town, near good schools and plentiful soccer fields, and you even have a specific look in mind—Tuscan stone, or country French with sculptured hedges that look like garden gnomes.
Your favorite banker, after checking your income and credit history, decides to give you $1 million to build your dream. But then, just as you’re ready to sign the dotted line, your hands shaking in anticipation, your heart all aflutter, your loan officer smiles and adds, “Of course, I expect you to use this money to hire my architect, my general contractor, my engineer, my electrician, my landscaper—in fact everyone you need to build your house is my choice, not yours.”
Your hand still quivering?
Would you put up with that? No one would, right? Well, before you pick up your Occupy banner and march off to protest the mortgage industry, let’s make one minor change to the story above and see how you feel.
You’ve worked hard to grow your business. You’ve invested in the right tools, hired the right people, cultivated the right vendor relationships. And now you’ve outgrown your space. You have a specific part of North Texas in mind that’s near important customers or suppliers or an employee base from which to draw new talent. So you meet with prospective landlords, each of whom quotes you a rate and then graciously offers you a Tenant Improvement (TI) allowance.
Now doesn’t that sound nice? An allowance. Just like when you were a kid. Mow the lawn, collect your allowance. But that’s not how this allowance works. Instead, a TI allowance is really no different than the loan the banker offered. They are not giving you money because you are in the 99 percent! They are not giving you money at all. They expect you to use that money to build out your space in their building.
So what, right? Most understand the consumer pays for everything. So you shrug that off and enter into negotiations with the landlord that offered the best deal. And then it happens: you’re handed a turnkey lease. What is that? A turnkey lease says the landlord will use your allowance dollars (the money just loaned to you) to build out the space just like you like it (Whataburger without the greasy mess?).
And that’s good, yes? You don’t have to do anything more but show up when all that nasty construction work is done. The landlord will use the money he loaned you to pay for his architect, his general contractor, his engineer, and his electrician. Oh, and one more thing, the landlord wants a 3 percent to 5 percent fee for doing so. So he loans you the money, then uses it to hire all his people, then charges you to spend it?
Your hand started quivering again yet?
But wait, turns out a lot of landlords (not all, probably not even most, so spare me the hate mail) have special relationships with architects, contractors, and other vendors they “allow” to work in their buildings. Often, these special vendors provide referral fees or discounts back to the landlord because they do so much business together. It’s kind of a volume thingy. You send a lot of work my way, I send you some money back. Get it?
There’s more! When a landlord gives you an allowance, say $35 a foot to build your space, you can rest assured they added plenty of contingency dollars just-in-case. They do so because the landlord is carrying all the construction risk. And risk costs money. But assume the job goes well and there is no just-in-case money needed; the project winds up costing $30 a foot instead of $35. Think you’ll see any of that $5 a foot? I’m just asking.
Believe it or not, this sort of thing happens daily across Dallas-Fort Worth, and throughout the country. In fact, in some cities, the deal-making, back room negotiations, and brother-in-law favors involved in the office construction trades would make a pole-dancer blush. So if you want to make sure the money loaned to you—which you are going to have to pay back—is used for your benefit and not that of others, first, do yourself a favor and ask some questions.
For instance, if a prospective landlord hands you a list of preferred vendors, ask what makes them preferred. And second, if you don’t like the landlord’s answers, think about hiring an independent project manager to represent your interests throughout the construction project. A good, ethical project manager often more than offsets their fees by keeping all transactions transparent, by making the market compete efficiently at every stop along the way, by finding ways to control pricing and risk, and by making sure a TI allowance is used to benefit the tenant. Third, think twice about such deal structures, because turnkeys can quickly morph into turkeys.