The Greater Lagos Island area, covering Victoria Island and Ikoyi, is home to a host of major companies and like any node, its real estate market can be positively or negatively affected by both national economic conditions and the local market realities.
On the national front, the Island real estate office market is currently experiencing a downturn due to falling oil prices and government policies that have resulted in limited occupier movement. At the local market level, there has been a notable oversupply of Grade A offices in the Ikoyi and Victoria Island as a result of target occupiers (such as oil companies and banks) choosing to stay put or downsize their requirements as a result of the economic conditions.
The combination of these factors has led to an increased vacancy rate in the Greater Island office market and this has prompted landlords to become more creative in in their approach to attract tenants in this competitive environment. How are they doing this? Largely through rental concessions which include quarterly payments, rent-free periods, and tenant improvement allowances – the most sought after incentive. We discuss tenant improvement allowances and rent-free periods in greater detail.
Tenant improvement allowance
A tenant improvement (TI) allowance is the amount that the landlord is willing to provide to the tenant for the build-out, retrofitting, refurbishment and renovation of an office space for the tenant’s specific use. This amount is decided upon during lease negotiation. From the tenant’s perspective, it is important to ensure the allowance is sufficient enough to cover the proposed fit-out costs, especially since the tenant maintains significant control over the fit-out process.
The TI allowance is structured in one of two ways:
- Provided as a lump sum to the tenant upon signing of the lease agreement.
- As a turnkey build-out where the landlord absorbs the fit-out cost based on the lease agreement and delivers the to the tenant’s office requirements and specifications.
With the lump sum arrangement, the tenant benefits from having a significant amount of control in the construction process. The tenant is at liberty to engage a project manager to manage the process from end-to end in order to secure the optimum solution in terms of quality, time and budget. The project manager could be drafted in the early stages of lease negotiations to provide test-fit office layouts which will be beneficial in estimating the cost of the fit-out. The estimated fit-out cost will be imperative as a guide for negotiating the TI allowance with the landlord.
Furthermore, the project manager is able to lead the bidding process for fit-out works, as well as other specialist work packages in order to select the best construction team who will deliver value for money for the client.
The turnkey build-out, on the other hand, puts control in the hands of the landlord who will take the ultimate responsibility of managing and delivering the interior fit-out works based on pre-agreed specifications. While this provides the tenant the benefit of a one-stop shop solution with a landlord who has the in-house staff and experience to deliver the product, there are some disadvantages for the tenant with this approach. For one, the tenant’s control of the project is greatly diminished and the build-out works might also not completely be in line with the tenant’s official requirements.
Another disadvantage of the turnkey approach from the tenant’s perspective is the cost of the build-out. Typically, landlords will allow for a contingency fee to prevent the actual construction cost from exceeding the pre-agreed estimate. Ideally, this contingency fee should be invested in the project and not used for the landlord’s profit.
A rent-free period is a period of time during the lease where the tenant is not required to pay any rent at all. This usually kicks in at the start of the lease agreement. The reason for this incentive is that it is usually expected that a tenant will require around three months to fit-out a space. During this time, the tenant is unable to use the premises and as such is reluctant to pay rent.
If the premises considered are in need of renovation works, the negotiations for a rent-free period should be harder for the landlord to resist. In calculating the rent-free period, the tenant should take into account how long the space has been vacant for, the general state of repair and the general marketability. Ideally, one should be able to apply a 1.5 month rent-free period for each year of the lease, until the first break period which serves as a starting point.
Considering the current economic downturn, it is expected that landlord concessions will continue to play a major part in attracting tenants to sign leases, as well as for relocating to much better facilities.
Co-authored by Gideon Adesiyan