The high cost of Office Dilapidations – Are you sure you can afford them?
By Crispin Maby
When looking for a new office to move into, the cost of rent, rates and service charges are not the only costs to consider. Making alterations and fitting out the interior space to suit your needs is another potentially large cost, but often overlooked is the cost of putting it all back as it was at the end of the lease – dilapidations. This can be a very nasty sting!
Most office occupiers will be aware of the end-of-term dilapidations lease clause which normally requires them to reinstate their office back to the same specification and condition it was in when they moved-in, but many are unaware of how far reaching and costly this can be. It’s not uncommon for the cost of dilapidations to be as much as, or even more than the amount they paid to have the office fitted-out in the first place. Yes, you read that correctly but I’ll say it again, in a different way. The cost of handing back your office to the landlord at the lease end could be greater than what you spent fitting it out when you moved in!! So, before you commit to a property, you need to be absolutely sure you can afford the cost of both fit-out and dilapidations. Even if you simply move straight in and do absolutely no fitting out (no partition walls, no new flooring, no electrics etc) there will almost inevitably still be a dilapidations cost in the end, and that could be substantial.
The cost of dilapidations is, to a certain extent, relative to the specification of the office space the landlord has provided (i.e. whether a new build or newly refurbished, what has been included and the quality of fit out) and how much the tenant then alters or adds to the space and causes wear and tear to the landlord-provided finishes. The newer and higher specification of the landlords building and their base fit-out, the more it is likely to cost you both in terms of your own fit-out and dilapidations.
Taking on a shiny new office can be a very exciting time for an expanding SME, but they must be sure they can afford it. Not only are there the rents, rates and service charges but also the cost of fit-out (a topic for a separate article) and dilapidations. It should not be overlooked that dilapidations, although maybe 5 or so years down the line, are going to come into play at exactly the same time that the company is having to pay out on the fit out of the next office they take on, so in effect potentially doubling the cost of the office move.
The landlord will be uncompromising. Whatever is stated in the lease agreement must be done. Try as they (the tenant) might to point out that they have made significant improvements, or that the fabric has only been subject to normal wear and tear, these justifications are highly unlikely to hold water. It is up to the tenant to identify these issues whilst drawing up the heads of terms so that if there are any justifiable exceptions they can be written into a legal contract. And if the office is not newly refurbished and in pristine condition, then the tenant must identify this and get an upfront agreement stating the exact condition of every surface (walls, ceilings floors etc), fixtures and services, and what measure is going to be used in order to determine how everything is going to be reinstated back to the same condition. This is not simple because, for example, the landlord might have left in place expensive carpet tiles which are in good condition but not new. After 3 to 5 years further use, it is most likely that these carpet tiles will be showing considerable wear, so what is the landlord expecting the tenant to do when they move out? Do they replace them with exactly the same brand and colour in the same ‘nearly new’ state they were found – unrealistic and almost impossible – or are they expected to replace them with brand new carpets, and if so, do they need to be the same tiles or can they be a budget range? Or do they simply come to an up front agreement that because they are not new and that it is impossible to therefore replace like with like, that an agreed settlement fee will be charged upon exit? So, defining and setting out in writing at the outset exactly what is required at the end of the term is essential.
If you are planning on doing anything that you consider will be a significant improvement to the office space, and that will be beneficial to the landlord in helping them to re-let it after you have moved out, then again this is something you must identify upfront and tie into a written agreement – either that you will not be required to remove these items, or perhaps that they will be allocated a monetary value that will be deducted from the dilapidations bill (although in such circumstances it would be more normal for the landlord to make an up front contribution towards such works. The sort of things that might qualify here would be the provision of (if not already in place) underfloor electrak power distribution systems, floor boxes, new and improved ceiling lighting and significantly improving wall and ceiling surfaces (perhaps re-plastering, drylining etc) if in a poor state initially.
Here’s another very important factor to consider. More often than not you simply won’t have time to carry out any dilapidations works yourselves. These works can not take place whilst you are still occupying the space, and although you might have all best intentions to leave sufficient time between moving into you new office and the lease-end date for the existing office, most often it goes down to the wire and the two dates coincide. Once the lease has officially ended, the landlord is highly unlikely to let your contractors back in for a few weeks (or even a few days) to carry out works and that means that you’re going to have to pay the landlord a settlement fee which is likely to be considerably higher than what it might have cost you if your own contractors had done the work. Furthermore, even if you do manage to get the work done yourselves, you have to be absolutely sure that the finished result is exactly what the landlord is expecting (or what is written into the contract) otherwise you could get another bill from the landlord over and above what you have already paid out to your contractors for them having to put it right themselves. In a nutshell, what I am saying is that when you enter into an office lease, you must consider the worst case scenario and ensure you have the budget to cover it.
So why does everything cost so much and what are those costs? I like to break this down into 2 areas: 1) Wear and tear or damage to landlord provided fixtures, fittings & services and 2) alteration works or additions that you have carried out.
Let’s look first at the landlord-provided aspect. Your new office is likely to be either Cat A or Cat B, or somewhere in between. Cat A is where the landlord has provided a base or basic fitout – basic in this case meaning essential services-only but not necessarily low cost or inferior quality. The essential services can, and very often are, done to a very high specification. For instance, it might have brand new high spec lighting and air conditioning, a new raised access floor and newly decorated walls and ceilings. Whatever you do with the office thereafter, however you might alter it or use it, you will normally be required to bring it back to exactly the same basic but quality state at the end of the lease. This would involve stripping everything out that you’ve put in, repairing (making good) any damage, and replacing any worn or damaged original fixtures and fittings so that it is ‘as new’. Normal wear and tear is usually not considered a ‘get-out’. You will have entered into a legally binding contract and agreed to replace or repair pretty much everything.
Any additions or changes that you make to the space during your own fitout would need to be removed and/or put back as originally presented. A typical example would be the occupier spends tens of thousands of pounds installing glass and solid partition walls, expensive carpet tiles and floor coverings, new lighting and much more, only to find that the landlord demanded that they remove it all, make good all the decorations and replace the carpet tiles with new carpet tiles of the same specification that was in place when they moved in. The outgoing occupier argues that they have made great improvements to the office so surely they should not be penalised for this. The landlord argues that even though the tenant replaced the original carpet tiles with much more expensive ones, they are now 5 years old and are showing signs of wear, whereas the carpets he fitted prior to their occupation, albeit of an inferior quality, were brand new. He will also argue that the layout of partitions is bespoke and is unlikely to suit another company’s needs, so it will make it more difficult to find a new tenant. The landlord does not want to foot the bill for stripping out and making good the office, and nor does the incoming tenant, so the onus is on the outgoing tenant to make things right at their expense.
So is this fair? Not always, but if that is what is in the legal document, that is how it must be. The main point I want to make, particularly to SMEs who may not be quite so experienced in these matters, is that the cost can be vast and run into £10s or £100s of thousands, so please, be careful!