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Defining Construction Costs In The Work Letter And Construction Allowance Documentation

Construction Allowance documentation usually gives the tenant some amount of construction dollars which are available to pay for the construction of tenant improvements. Allowances are normally based upon the square footage of the premises, e.g., $48 per rentable square foot. That being said, does the documentation specify exactly which construction costs qualify as expenditures under the allowance?

Often, it is obvious, such as in the case of construction materials used in the premises. Likewise, it is often clear which costs should be excluded, such as in the case of costs for the base building structure, and in the case of building standard work furnished to all tenants by the landlord. However, in many other cases, it is not entirely clear whether costs should qualify.

The parties to the lease and the construction allowance exhibit should probably include a carefully drafted definition of “construction costs” in the documentation. For example, the working definition of construction costs frequently includes:

  • the cost of all labor, materials, and fixtures (but not trade fixtures) supplied by the contractor and subcontractors;
  • taxes, licenses, charges and levies imposed by governmental authorities in conjunction with the construction of the improvements in the premises;
  • fees paid to engineers, architects, interior designers, and space planners to prepare plans, specifications and drawings for the work;
  • fees paid to utilities to connect to the premises, as opposed to the overall “trunk” lines for the entire retail or office complex;
  • the cost of on-site inspection, administration and supervision of the construction process; and recording and filing fees required by the construction.

The Gray Areas

It may also be advisable to expressly include or exclude certain items from construction costs, because they have the potential to cause misunderstandings between the landlord and the tenant when the parties review the accounting for tenant improvements. Such potentially contentious costs include the following:

  • costs for work performed before the lease was signed;
  • off-site improvements such as streets, curbs, gutters, parking lights, street lighting, and so forth;
  • improvements made outside of the demised premises;
  • building-wide systems such as elevators, HVAC, electrical panels, staircases and the like;
  • the cost of items furnished by the landlord as “building standard work” above the “base building construction”;
  • costs for items not shown or detailed in the approved plans and specifications for the tenant improvements;
  • costs covered by warranties and insurance;
  • premium or “overtime” wages and costs incurred to complete tenant improvements on time;
  • financing costs, points and fees expended in connection with the financing of the tenant improvements;
  • costs or premiums for performance bonds, mechanics’ lien bonds, completion bonds, and payment bonds;
  • insurance premiums for builder’s risk insurance, liability insurance, or casualty or worker’s compensation coverage;
  • costs of interior or exterior tenant signage;
  • costs to remedy construction defects;
  • costs to remove or abate asbestos, PCB or other hazardous materials;
  • charges to rent construction equipment used to construct the tenant improvements;
  • costs of changes to the plans and specification required by governmental authorities, and the cost to retrofit such changes if the affected improvements have already been constructed;
  • general overhead of the landlord or tenant, or of their respective contractors or agents;
  • legal fees related to the construction contract and construction management contract negotiated and executed by the landlord, the general contractor, and subcontractors for the tenant improvements; and
  • legal fees related to any disputes arising during or after construction of the tenant improvements.

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