Whether your current office simply needs a face-lift or it’s finally time to move to a bigger space, few projects are as thrilling — or as daunting — as managing an office build-out. Not only must you deal with a never-ending stream of contractors, suppliers and invoices, you must also figure out how your firm will actually pay for all those gorgeous new desks and that fancy new lobby.
Luckily, you have options. Although build-outs may be complicated projects, financing these projects can be more straightforward than you think. Typically, your finance options will boil down to three approaches.
BANK LOAN OR LINE OF CREDIT
This is perhaps the most common finance solution. If your firm has a good bank relationship, obtaining bank financing may be a straightforward, easy process.
Keep in mind, though, that many banks will not loan against soft costs, such as construction services or software — meaning your firm may need to cover those costs in some other way. Additionally, tapping into a line of credit for a build-out may prevent you from accessing that line for other, more critical working capital needs.
TENANT IMPROVEMENT (TI) ALLOWANCE
In some situations, landlords will add a TI allowance to the rental agreement to sweeten the deal. Expressed as a lump sum or per-square-foot amount, it can be used to renovate or retrofit the leased space. However, a TI allowance may not be sufficient to cover all of your build-out expenses. The allowance may also be stipulated for certain project costs such as construction but not furniture.
LEASE LINE OF CREDIT
For many firms, a lease line of credit can solve many of the issues with traditional bank financing and TI allowances, including:
Ability to finance 100 percent of a project’s costs. A lease line of credit can include all expenses related to the build-out, including both hard and soft costs. Build-out expenses such as architectural fees, construction, wiring and cabling, audio-visual setup and carpeting can all be included in a lease along with furniture and fixtures.
Reduction in the tax burden. Lease payments are recorded on your income statement, which means they are tax-deductible operating expenses. This can reduce your firm’s tax expenses far more than the depreciation expenses you would claim if you booked your new equipment purchases as assets on your balance sheet.
Diversification of funding sources. Traditional bank financing may include covenants that limit your ability to add new liabilities to your balance sheet. A lease line of credit avoids those covenants and provides you with off-balance-sheet financing. Leasing will also prevent your firm from becoming too dependent on any single source of funds, which can ensure stability and peace of mind in an unpredictable finance environment.
Distribution of costs over time. Your firm’s employees will realize the benefits of your office build-out for years to come, so why should your equity partners shoulder 100 percent of the costs today? Leasing provides you a fixed-rate financing arrangement where you can spread the build-out costs over a five- to eight-year period. Particularly for large projects and expensive equipment upgrades, this may be a smarter long-term approach.
Prevention of phantom income. With traditional financing, the tax depreciation of office improvements is typically less than the cash expense. This creates a higher taxable income compared to book income, which means your equity partners will be taxed at a higher level. A lease program eliminates this phantom income drag.
As you weigh your finance options, ask yourself these questions:
- What is the overall cost of our build-out and how much does the TI allowance cover?
- How long of a financing arrangement would make sense?
- Would the firm be depreciating the assets for longer than the occupancy of the space?
- Would spreading out the cash flows of the acquisition make sense?
- Would easing the equity partners’ tax burden be an important factor to consider?
You have many options, so take the time to select the approach that provides your firm with the most advantages over the long term. And be sure to sit back and enjoy your beautiful new space. You’ve earned it!
About the Author
Christina Floyd is a Certified Lease and Finance Professional (CLFP) and has almost a decade of equipment leasing knowledge and dedicated experience working with the legal industry. Additionally, she has successfully completed the Legal Management Finance Specialist Certificate Program through ALA. In her tenure, Floyd has been instrumental in growing First American’s legal business to more than 200 firms.
Karen Leastman has more than a decade of equipment leasing knowledge and dedicated experience working with the law firm industry. Since joining First American in 2003, she has been a key contributor in building First American’s law firm division which now serves more than 200 law firms across the United States, including Am Law 100 and 200 firms. As a Certified Lease and Finance Professional (CLFP), Leastman is a leader in the equipment leasing industry.
Funding Your Office Renovation, Relocation or Remodel.
Join Christina Floyd and Karen Leastman at ALA’s Annual Conference & Expo this May in National Harbor, Maryland, as they expand on this subject matter in their session. They also recently joined us to discuss this topic on Legal Management Talk. Download through your podcast app, or listen here.