Budget Quotations vs. Contract Bids

Q:  We are contemplating a comprehensive renovation of our existing office space, and would like to get some idea of the cost.  Should we be getting multiple bids?

A:   Yes, you should eventually get multiple construction bids, but that is not what you need right now!

If you are planning commercial construction or renovation, there are two types of construction estimates.  You need to be aware of the advantages and disadvantages of both. A “budget quotation” is a rough estimate of the costs of construction which is prepared without a lot of detailed information on the quality or type of materials. A “contract bid” is a price for which the contractor is prepared to build, and is usually based on a complete set of drawings and/or outline specifications.

What you need at the moment is a budgetary quotation, and obtaining a quotation from just one reputable contractor will usually suffice. Why would anyone want a budget quotation?  Hunt Construction Services recently provided a budget quotation to a Huntington businessman who was interested in expanding his building. An architect had prepared a single page plot plan showing an outline of the proposed addition on the site. That’s all there was. But it was enough for a budget quotation. In this case, a budget quotation helped our client make a GO/NO-GO decision.  Will he be able to finance the addition? Will the additional carrying costs and taxes be more than offset by the additional business that can be booked? Our client did not want to bear the cost of a full set of architectural drawings before having an understanding of the scope of the project.

For the budgetary quotation, a contractor will need to have a reasonable idea of the demolition involved, lineal footage of new sheetrock, number of interior doors and level of finish (carpet, wall coverings, ceiling etc.) When our firm provides budgetary quotations, they are not a rough guess! We will break down the budgetary quotation by trade, and show you our assumptions and their associated costs. Now you have a fairly good idea of the cost of the project and can begin to make some intelligent decisions about the feasibility, scope or specifications of the project.

Unlike a budgetary quotation, a contract bid should be based upon very tight specifications (down to the last doorknob) and a complete set of plans. So once you have made the decision to move forward, an architect (or in some cases, a space planner) should be hired to prepare drawings and specifications. Only when those drawings are complete do you ask at least three reputable contractors to bid the work.  Because the drawings reflect the work down to the last detail, there is no room for guesswork on the part of the contractor. If these drawings and specifications are not done, the result will be construction bids that vary widely based upon what each contractor believes you want. So a complete set of plans is the last place where you want to skimp!

If price is not that much of a consideration, you can safely skip the budgetary quotation and go straight to construction drawings. But on any major project never, but never, skip the construction drawings and multiple construction bids!

The Total Cost of Relocation

Q:  Can you provide some ball-park costs associated with relocating our company? We’re concerned that these secondary costs may get out of hand.

A:  You have a right to be concerned. I am always surprised at the companies that will negotiate the price of their new facility down to the last dollar, without thoroughly analyzing their other relocation costs. It is way beyond the scope of this column to provide estimates, particularly since these costs vary widely from one company to another. However, experts and vendors in each field are usually available to assist you in budgeting.

In addition to the actual real estate itself, the following are the major areas of cost control that should be anticipated in a commercial move:

Soft costs: This refers to all the non-tangible real estate acquisition costs such as title insurance, legal representation, survey, appraisal, architectural and the like. Check with your attorney for an estimated closing budget. If substantial architectural or engineering is contemplated, this needs to be budgeted as well.

Renovation, refurbishment, and repair: This can range from nothing or negligible (if, for example, a landlord is doing the work) to very extensive construction costs. For any substantial work, you need written specifications and multiple bids.

Environmental reports, environmental legal advice, and remediation: In the case of industrial properties, this may be an area where it is advisable to pay for some basic research before you sign a contract or lease. You cannot do enough homework in this area.

Future shipping and travel expenses:  How will the new location affect trucking and shipping, as well as employee and customer travel times?

Utility costs:  Are you moving to a more or less efficient building? How will different operations in a new building affect utilities, e.g. multiple shifts and new machinery? Are there incentive programs from local utilities to offset costs?

The physical move:  Obtain quotes from several reliable commercial movers.

Downtime:  Figure the downtime of the actual move itself, and also in the case of complex moves or acquisitions, the cost of the payroll for the employees who are handling the real estate, construction, and the physical move.

Employee impact: After the move is no time to find out that you are losing several key employees because their commute was increased by 30 minutes. What is the labor market in your new location, and how will that impact your payroll?

IT and Telecommunications:  This can be huge, depending on your needs and what is already in place in the new facility. Again, you require specifications and multiple bids.

Printing: Stationery, business cards, literature and other similar printing all need to be redone.

This is not meant to be an exhaustive list – rather a quick list to get you thinking and developing your own checklists. Start early, and refine your budgets as real estate alternatives are refined.  Anticipating these costs, and sharing them with your broker, will go a long way toward making smart real estate decisions and controlling these costs.

Forget the Price!

Q: We are just starting to look for new office space. Why does our broker insist on showing us space that is out of our budget?

A: Unless your broker is offering you space wildly out of the budget, he is absolutely correct to be ignoring the asking price in showing you new office alternatives. Here are the five reasons that this is the right strategy and why you should “forget the price” on your initial forays.

  1. Every listing has a story. Each property has a history, and an owner with a set of priorities, needs, and emotions. Without discovery and negotiations, it is very difficult to know at the outset the exact point at which a deal can be consummated. In some cases the broker may have some intimate knowledge of the situation, perhaps from a previous negotiation. However, since most commercial brokerage agencies on Long Island have access to literally thousands of commercial properties, it is simply impossible for your broker to have bottom-line knowledge on each one.
  2. The property may not be correctly priced. Both brokers and owners have their reasons for setting the asking price where they do. Sometimes this decision makes sense in the marketplace, and sometimes it is wildly optimistic. Either way, the price eventually will be driven down to a market level. I have told owners for years, “I can lie to you, you can lie to yourself, but the market never lies.”
  3. The cost of the space is not necessarily the cost of acquisition. What looks like a bargain may not be, after all the hidden charges or costs of occupancy have been added up. As an example, a higher-priced location may have salvageable telecom cabling or built-in furniture, both of which could save you thousands of dollars.
  4. You must not compare “apples and oranges” (particularly with office space.) Comparing two face rents makes no sense at all if, as an example, you have not incorporated into the comparison, the loss factor in the building, the escalation clauses, utility charges, and overtime electric.
  5. There are reasons you might want to consider paying a higher price. Better parking, local restaurants, backup power capability, and available business services are all examples of reasons that you might want to consider paying a higher rent to provide a better work environment for your employees, or to make your business more productive.

We highly recommend to our clients, in the initial process, that they concentrate on the utility of the alternatives under consideration, without regard to price. Once we understand which alternatives best suit the needs of our client, the process of discovery and negotiation can begin. Of course, ultimately, the cost will play a very significant role in the final decision-making process.  But in the beginning, you should “forget the price!”

Lease Options

Q:  Our company is negotiating a long-term lease for a new manufacturing facility. How important is an option to renew or purchase?

A:  The definition of an option is a provision in an agreement that gives one party the right, but not the obligation, to exercise a right of some kind. This is important to keep in mind when negotiating tenant options in a lease. A tenant option gives the tenant the right, but not the obligation, to renew, to purchase, to expand or to perform some other action. If and when a tenant exercises this right, the landlord must comply. Thus, all things being equal, it behooves the tenant to negotiate as many options as possible. It is to the landlord’s advantage to negotiate as few tenant options as possible. One ordinarily thinks of an option being a tenant’s prerogative, but in fact, landlords may also have options, such as the ability to terminate the lease or relocate a tenant. In any case, the advantage always goes to the party that may exercise the option.

From a tenant point of view then, the best strategy is to negotiate as many options as possible.  Here is a key point: Since an option is almost a future event, and no one has an accurate crystal ball, a tenant is always better off taking what seems to be a worthless option than no option. If negotiation with your landlord yields only an option to purchase at what seems a ridiculous price, take it. If the price is above market at the time that the option may be exercised, you will ignore it, and offer to negotiate with the landlord. But if it is below market, you may exercise it and the landlord has no recourse. Thus, options are sometimes labeled “a one-way street.”

So why would a landlord offer an option? Options are market driven. In a strong sellers’ or landlords’ market, options may be dear and expensive. In a high vacancy market, landlords will use options to create incentives to lease. Landlords are often very uncomfortable in providing options at a fixed cost, particularly many years into the future. Thus it is common to see “fair market value” options. These are options that allow a tenant to renew or purchase at a price that is supposedly at fair market value when the option is exercised. This, of course, requires some ingenuity on the part of the landlord and tenant in agreeing on the definition of fair market value.  You should also be aware as a tenant, that a landlord has considerable cost savings in renewing your lease as opposed to finding a new tenant. A new tenant may require costs that include additional brokerage and construction, not to mention vacancy and the associated lost rent. So it is common to see renewal options set at some percentage of fair market value, such as 90%.

Because you are negotiating a lease for a manufacturing facility, I would assume that there will be significant capital expenditures on your part that need to be protected with a long term lease or, perhaps, an eventual purchase. Landlords of such facilities are usually aware of your needs and would be unable to lease their buildings without providing their tenant the right to amortize heavy capital outlays. Thus, the negotiation of options is vitally important in your situation.

Now is the Time to Sell

Q:  Our company needs to expand out of a 20,000 square foot building we have owned for the last seven years. Do you have any recommendations on whether we should buy or lease larger quarters? Should we sell our present building? 

A:  Let me start by issuing a caveat: Your circumstances are individual and are probably best addressed by your CFO or accountant. In general, however, the commercial real estate market on Long Island today favors selling your existing real estate and leasing the replacement facility.

Why is this so? There is a wide disparity between the cost of purchasing and leasing commercial real estate on Long Island due to low-interest rates and an influx of purchasers relocating from Brooklyn and Queens. Many industrial buildings that have been sold recently had multiple buyers waiting in line to purchase. The demand for these building has far outstripped the supply.

For many years, we had a very stable relationship between purchasing and leasing, with the cost of purchasing approximately 10 times the cost of net leasing the same building.  As an example, if you could net lease a building in the past for $7.00 a square foot net, you could expect to pay $70.00 a square foot to purchase the same building.

Today, a lease price of $7.00 a square foot may have a corresponding sale price of $125.00 a square foot. The cost of purchasing is over 17 times the cost to lease! If you are fortunate enough to own your present facility, you have the opportunity to make this leverage work for you by selling your existing building and leasing a new one. You will be effectively winning on two ends – capitalizing on both a strong market to sell, and on a relatively softer market to lease new space.

There are some added bonuses to this maneuver as well. A sale of your current facility frees up capital tied up in “bricks and mortar” and allows it to be spent on the core business activity of your firm. Leasing has become the preferred method of occupying real estate by Fortune 500 companies, as they intensify their efforts to concentrate on core business and outsource non-core functions. In addition, leasing provides your firm with an easy and known exit strategy. In a fast changing business environment, flexible real estate terms are often the key to managing real estate costs. For these reasons, most of America’s largest companies have divested themselves of their real estate holdings and prefer to lease.

The very best way to analyze the objective side of the decision is a discounted cash-flow analysis of a sale vs. lease for both the disposition of your old facility and acquisition of the new one. This will give you the present-value cost of each alternative, allowing relatively easy financial comparisons. There may be other factors at work as well, some of them subjective, but this is a good place to start.

I recommend hiring a real estate professional to provide you with comparable numbers for selling your facility and leasing a new one, as well as assisting you with the financial analysis. There is a really good chance a windfall awaits you!

Contingencies in a Contract of Sale

Q: We are negotiating the sale of our industrial building, and the buyer is insisting on a long list of contingencies in the contract. What is normal?

A: There is no “normal” set of contingencies to a contract of sale, in the same way there is no “normal” real estate deal. Contingencies are simply another set of business terms that are agreed to by a buyer and seller. I have negotiated contracts that permit the buyer to cancel within a specified period of time for “any reason or no reason,” as well as contracts that took three or four years to close because of rezoning contingencies. And I have also negotiated a contract with absolutely no contingencies, in which the buyer conducted a title search and environmental research without the benefit of a contract (very unusual!)

What is a contingency? It is basically an option given to the buyer to cancel the contract under a set of specified conditions. As an example, a buyer with a financing contingency may generally cancel his contract without obligation (and receive a full refund of his down payment), if he is unable to secure financing upon terms stated in the contract. Generally speaking, the objective of the seller is to negotiate a contract with as few contingencies as possible. The buyer, on the other hand, desires to maximize the number of contingencies to allowing him maximum flexibility if he discovers problems during the contract period.

The two most common contingencies in a commercial contract of sale are a marketable title and an environmental review. Even if a buyer would be willing to waive these contingencies, his lender (if he has one) will insist upon a title search and a Phase I Environmental Assessment. There is no “standard” language for these contingencies. The language that is drafted can be either quite generous to the buyer, extremely limited, or somewhere in-between. For example, if an environmental problem is found, the buyer may not have an unfettered right to cancel the contract. It is not unusual for the seller to have the right to cure the problem up to a specified limit, $50,000 – $75,000 being common.

In the end, you have to evaluate the contingencies that have been presented to you in light of your relative bargaining position. If you have multiple parties interested in the property, then you are in a position to be more demanding of a short list of tightly worded contingencies. If you have relatively little other interest in your property, then you may be forced to acquiesce to a more liberal set of contingencies.

If you have to agree to a longer list, try to limit the contingencies as much as you can. As an example, if you are willing to make the closing subject to financing, try to specify the amount and rate at which the contingency is valid. If you specify a loan-to-value ratio of 65%, instead of 75%, you increase the likelihood that your buyer will receive a financing package.

I highly recommend that you seek the benefit of legal counsel before agreeing to any contingencies. Your attorney will not only have suggestions on what contingencies should be included in your particular situation but will also give you some ideas on limiting those contingencies.

How to Slash Commercial Construction Costs

Q: I nearly fell off my chair when I received a quote from a general contractor to renovate and enlarge our office space.  I had no idea that costs had climbed so high. Any suggestions?

A: Yes, there is a way to slash 10% or more from your commercial construction project. It is a method of running construction projects called Construction Management. It is not the same as General Contracting, in which a general contractor quotes one price to complete the entire project. It is common for a general contractor to total his costs (both his subcontractors as well as other costs) and then add 20% for overhead and profit.

Construction Management is completely different. In this model, you hire a construction manager to manage the project for you. The construction manager is paid a fee, usually a percentage of the project cost. This fee is usually less than 10%. Thus the cost of a project utilizing Construction Management can easily slash 10% or more from the cost of your project. Let’s take a look at the advantages of Construction Management.

One of the reasons that I am a big proponent of construction management is the complete transparency provided to the client, and the elimination of inherent conflicts. In general contracting, it is in the financial interest of the general contractor to buy the cheapest products and services, since by doing so, he will increase his profit. The construction manager, on the other hand, has nothing to gain by doing so. Each product or service is put out to multiple bidders (including any that may be introduced by you.) You and your construction manager can then make the best cost/benefit decision from multiple bids. The entire process is open and transparent.

You will also have complete control of the project and choose what decisions to make yourself, and what to delegate to your construction manager. In essence, the construction manager is assisting you as you act as your own general contractor. Since the construction manager is your agent, you will have complete control over the building process, including negotiating with suppliers and subcontractors. You can be as involved as you wish – every day or seldom. Either way, you have a professional managing your construction with a fiduciary responsibility to protect your interests.

Another advantage of Construction Management is that if there are potential savings to be achieved during construction (perhaps a special buy, or discounted services from a subcontractor), the savings are yours. This is not the case with General Contracting, in which the contractor will pocket the savings as additional profit. And finally, it is not uncommon for a general contractor to charge exorbitant costs for change orders. In essence, you are almost forced to pay what he demands for changes during construction. This is not the case in Construction Management, where once again, there is complete transparency and change orders are submitted out for bid.

So, Construction Management is the way to substantially reduce the cost of your construction, usually by 10% or more.

Contingencies in a Contract of Sale

Q: We are negotiating the sale of our industrial building, and the buyer is insisting on a long list of contingencies in the contract. What is normal?

A: There is no “normal” set of contingencies to a contract of sale, in the same way there is no “normal” real estate deal. Contingencies are simply another set of business terms that are agreed to by a buyer and seller. I have negotiated contracts that permit the buyer to cancel within a specified period of time for “any reason or no reason,” as well as contracts that took three or four years to close because of rezoning contingencies. And I have also negotiated a contract with absolutely no contingencies, in which the buyer conducted a title search and environmental research without the benefit of a contract (very unusual!)

What is a contingency? It is basically an option given to the buyer to cancel the contract under a set of specified conditions. As an example, a buyer with a financing contingency may generally cancel his contract without obligation (and receive a full refund of his down payment), if he is unable to secure financing upon terms stated in the contract. Generally speaking, the objective of the seller is to negotiate a contract with as few contingencies as possible. The buyer, on the other hand, desires to maximize the number of contingencies to allow himself maximum flexibility if he discovers problems during the contract period.

The two most common contingencies in a commercial contract of sale are a marketable title and an environmental review. Even if a buyer would be willing to waive these contingencies, his lender (if he has one) will insist upon a title search and a Phase I Environmental Assessment. There is no “standard” language for these contingencies. The language that is drafted can be either quite generous to the buyer, extremely limited, or somewhere in-between. For example, if an environmental problem is found, the buyer may not have an unfettered right to cancel the contract. It is not unusual for the seller to have the right to cure the problem up to a specified limit, $50,000 to $75,000 being common.

In the end, you have to evaluate the contingencies that have been presented to you in light of your relative bargaining position. If you have multiple parties interested in the property, then you are in a position to be more demanding of a short list of tightly worded contingencies. If you have relatively little other interest in your property, then you may be forced to acquiesce to a more liberal set of contingencies.

If you have to agree to a longer list, try to limit the contingencies as much as you can. As an example, if you are willing to make the closing subject to financing, try to specify the amount and rate at which the contingency is valid. If you specify a loan-to-value ratio of 65%, instead of 75%, you increase the likelihood that your buyer will receive a financing package.

I highly recommend that you seek the benefit of legal counsel before agreeing to any contingencies. Your attorney will not only have suggestions on what contingencies should be included in your particular situation but will also give you some ideas on limited those contingencies.

General Contacting or Construction Management?

Q:  We will be closing on an industrial building shortly, and will need to reconstruct approximately 12,000 square feet of office space. I have heard that Construction Management is a better way to build. Is it, and how does it work?

A:  There are two major ways to hire a contracting company to work for you. The first and most traditional method is called General Contracting. In this model, you and an architect produce plans and specifications for the work to be done. Most often, a bidding process between several reputable general contractors would then be orchestrated by your architect. It is important that the plans and specifications be as detailed as possible, specifying quality, and in many cases, brands or equivalents. This is the only way that you will achieve an “apples vs. apples” comparison between several general contractors.

The chief advantage of General Contracting is that your work is being performed at a fixed cost, established through competitive bidding and that the contractor is assuming a certain amount of risk in fixing the price. If the work takes longer, or he runs into unforeseen difficulties, it is his financial burden, not yours. Typically his bid will be broken down into several categories:  labor, material, subcontractors, fieldwork, general administrative expense, contingencies, and profit.

Construction Management is a newer model of performing the same type of work. A construction manager acts as the agent of his client, hiring subcontractors and authorizing payments to them directly from the client. A construction manager is typically paid a percentage of the project cost. The advantage of this delivery system is that you, as the client, have complete control over the process. In essence, the construction manager is assisting you as you act as your own general contractor.  Since the construction manager is your agent, you will have complete control over the building process, including negotiating with suppliers and subcontractors.

Another advantage of Construction Management is that if there are potential savings to be achieved during construction (perhaps a special buy, or discounted services from a subcontractor), the savings are yours. If a General Contractor were to have the same opportunity, he could pocket the difference as additional profit.

The downside to Construction Management is that you have no peace of mind with regard to the final cost and you are also assuming all the risk of unforeseen issues.  Since Construction Management has the more financial risk, the cost of hiring a construction manager is generally going to be less than hiring a general contractor.

So there really is no “one size fits all” answer to your question as to which is the best method. It is a personal decision that takes into account your risk-tolerance and pocketbook!

Evaluating the Buyer

Q:  We are selling an industrial building and have multiple offers that are very close.  Besides price, how else would you evaluate the offers in making a final decision? 

A: This has been a common occurrence on Long Island in the last few years (and frustrating for buyers) as increasing demand has chased a dwindling supply of commercial properties. While price is certainly important, it is not the only criterion.  If two prices are relatively equal, I would be more concerned about which offer is more likely to close, and how quickly it will close. So let’s look at some of the items that may contribute to a fast and successful closing.

The Purchaser: This is usually a subjective decision.  As an example, a large public company may be a desirable buyer because it is financially strong, but undesirable because there are layers of management involved in the approval process. Or a company that needs to occupy the building in five months because of an expiring lease may have more motivation to close than an investor who is hoping to find a tenant. So take a close look at the buyers and their motivations, and ask yourself who needs the deal the most.

Financing: If the contract is to be subject to financing, you must have reasonable assurance that the purchaser can achieve the financing. I ask for a full set of financial statements. After I evaluate them, I ask a mortgage professional to do the same. If the purchaser is looking for a high loan-to-value ratio (LTV), will it be reasonably granted? If the purchaser has identified his lending institution, I like to pick up the phone and chat with the lending officers. Of course, an all-cash deal with no financing contingency is much more desirable, all other things being equal.

Other Contingencies: The two other major contingency items are a title and environmental. The first is rarely an issue in comparing buyers, but the second can be huge. There is no commercial property that is being sold today without an environmental report and a contingency associated with it. The important item to be negotiated is what happens when an environmental report is positive and remediation will be necessary. I cannot discuss all of the possible alternatives in this column, only point out that two different purchasers may consider different alternatives, one of which may be more advantageous to you.  (And, of course, the purchaser with the fewest contingencies is usually to be preferred.)

Timing and Cash Down: You will naturally favor the buyer who can close more quickly, all other things being equal. And from your point of view, the fewer rights the purchaser has to delay the closing, the better. Also look for a substantial down payment. Avoid purchasers who are offering down payments that are little more than “option” payments that permit them to walk away.

Representation and Legal Counsel: And finally, I am more likely to have a “warm and fuzzy” feeling with a purchaser who is well represented, by both broker and attorney. The likelihood of closing is much stronger if both are well respected in the industry, as well as professional in their conduct.

There may be other issues or concerns that arise, but a review of these items is a great start in comparing multiple offerings, making a decision, and quickly achieving a successful closing.