FLIP-FACTOR

LANDLORDS, PROPERTY MANAGERS SHOULD BEWARE OF THE ‘FLIP FACTOR’

What happens when it’s time to “close up” the open office? That is, what do landlords have to go through when an open plan tenant vacates the space that was built out originally for a more “traditional” company?

Open plan characteristics can vary widely, but most consist of twelve-foot ceilings (or higher), exposed ductwork, perimeter windows, if available, very low or no walls, and concrete slab or other hard-surface flooring. Throw in sprinkler re-alignment, suspended lighting, and a general aesthetic clean-up of excess wiring, old paint, dust and dirt, and the open plan bears virtually no resemblance to the standard office grid, still favored by the vast majority of today’s tenants.

If an open plan tenant moves into a new building, the landlord has the significant benefit of building out that space for the first time. Once that tenant’s lease is up, the landlord essentially has two choices: leave the space as is and market its existing assets to a similar open-plan tenant, or flip it back to its original condition and market it as standard office space. The latter obviously requires “closing up” that space.

That’s the typical approach in a new building. It’s another story altogether if the landlord leases space to an open plan tenant in an existing building. In that case, the landlord must rip out what is usually perfectly fine finish materials to satisfy open plan requirements, and potentially build it back out as a standard office as soon as five years later as the tenant’s lease runs out. Older buildings pose even more challenges to this method, especially when landlords are not exactly sure what lies above grid, or when accurate documentation may be lacking.

Confusing? It certainly can be. Why would a landlord even consider such an extreme demolition-to-build-out cycle after such a short lease term? And who pays for it all? The answer is in the market. In fact, it’s always in the market.

Landlords need to fill their buildings. Period. In order to accomplish this, they must be prepared to compete, which means appealing not only to the majority of tenant types, but also to those who represent a trend, or certainly, a paradigm shift, in which the American office market still finds itself. That is not to say that the open plan office is a new movement. It’s not. In fact, open plan offices have been around for decades, evolving and adapting to technology and cultural demands. But the fairly recent rise in millennial office workers is largely responsible for the sharp incline in open plan offices.

Consequently, landlords are prepared to take more risks when handing out tenant improvement dollars for these types of build-outs. It may serve this type of tenant to opt for a longer lease term, which is what the landlord would obviously prefer, but that doesn’t always happen. So landlords have to be prepared for the possibility of flipping a “standard” office suite into an open plan layout and back again within a five-year span.

This is very good news to the construction industry, at least for those companies specializing in tenant finish. Indeed, tenant improvement projects nationwide have jumped a significant 14.2 percent since the second quarter of 2013, according to a feature late last year in the digital edition of the World Property Journal. The Journal noted that “this is especially prevalent in office markets that are saturated with new construction and renovation.” That pretty sums up metro Denver as landlords continue to pay a higher tenant improvement dollar for “customized” open plan space. And it’s not cheap.

It costs approximately $20 per square foot to convert a 10,000 square foot office suite with standard grid into what most of us would term an open plan space. Call it “industrial” or an “urban loft” or something else, but the construction component includes removing all of the ceiling grid, lights, HVAC, and whatever else may happen to show up that wasn’t planned for. Mechanical trunk lines must be removed, sprinklers must be turned upward, and all lighting must be suspended. Sometimes the floor is stripped down to concrete, which must be leveled, repaired, and sealed. There are engineering and architectural “soft costs” all along the process, and those fees can sometimes be significant.

Returning that same suite back to its pre-open plan layout costs another $10 per square foot in construction alone. While it seems like a waste of time, money and materials to flip tenant spaces back and forth within a fairly tight timeframe, landlords are accustomed to doing it. It’s the cost of doing business and a risk that must be measured case by case. And every detail must clearly be spelled out to all parties in a marketplace as competitive as this one. While that might seem like ridiculously oversimplified advice, it clearly is not.

It is not uncommon for even the sharpest landlord or property manager to miss something unseemly above grid, for example. It happens, especially when deals are getting done at breakneck speeds. One open plan tenant found itself with a sweeping lead shield in the plenum to protect occupants from x-rays being performed in the medical office above. Another had to deal with hot water heaters nestled in the ceiling corner for a tenant’s kitchen on the second floor.

Some landlords include a clause in the lease that calls for the tenant to return the space to building standard condition upon departure to account for the “flip factor” associated with open plan conversions.

The point is, the landlord can negotiate virtually anything into the lease or the work letter. So can the tenant. Landlords are already paying top dollar for open plan tenants. In this market, they should take extra care in protecting their assets, especially when such rapid change is the new normal.

Tia Jenkins is President/Architect at KIEDING. She can be reached at tjenkins@kieding.com. This work originally appeared in the January 2016 issue of the Colorado Real Estate Journal’s Property Management Quarterly.