November 13, 2023

It’s a game of chicken: the complications of construction delays

The process seems so straightforward: a retail tenant needs space. Their broker finds the right place. The landlord agrees to specified improvements. A timeline is agreed upon by everyone. A lease agreement is signed.

And then it all craters, over an unforeseen delay. It could be a supply-chain issue; relying on the availability of materials has never been more tenuous. Or it could be trouble getting a permit because so many municipalities inadvertently strangle people with yellow tape. Either way, when the delay hits no one knows what the real timeline will be now, and both sides start getting itchy.

I can sum up the crux of the problem in four words: lease commencement versus rent commencement. The tenant gets a commitment from the landlord that the space will be customized to their needs, and available for move-in at a certain date. The landlord gets a commitment from the tenant that they will begin paying rent on a certain date.

When a delay interrupts the timeline, it gets messy. Once the lease agreement is signed, the tenant has an expectation of a finished space before they start paying rent, and the landlord has an expectation of when they’ll start getting rent revenue. A delay means someone—maybe everyone—is not going to get what they were promised. And that also means someone is going to take a financial hit. Who will it be? It’s a game of chicken that no one signed up to play, but everyone is a part of.

What can blow up the process?

We’re hearing it from tenants, landlords and vendors: the most significant obstacles to lease timing are permits and the supply chain.

Today’s supply chain problems are well-chronicled; the entire system has been unreliable and unpredictable since Covid hit. But one of the most insidious barriers is the permitting process—something the general population doesn’t even consider, including most tenants. Municipalities dictate the permit timeline, and oftentimes, they don’t know how long it will take.

One factor is that Oregon doesn’t have a sales tax, so there’s no incentive for municipalities to move quickly to get retail tenants up and running. In places with sales tax (meaning, 45 of the other 49 states), the sooner a retailer opens for business, the sooner the city gets revenue. It’s a powerful incentive, one that doesn’t exist in Oregon.

Both kinds of delays create an untenable situation that disadvantages everyone involved.

Everyone can lose at this game

When a delay holds up a lease situation, everyone has to bite the bullet in one way or another. The lease timeline starts far out, and typically the obstacle(s) arise only in the last steps. It means a compromise, but no one comes out unscathed. The question becomes, who takes the biggest hit?

  • The landlord may have to decide that this tenant is not going to work out and start over. Or they have to bide their time waiting for the situation to resolve. Either way, they’re wasting time and money—they’re losing rent, and it can threaten their ability to cover their own costs on the property.
  • The prospective tenant has planned everything around this move and this timeline. They may be ending a lease somewhere else and need to vacate. If the landlord decides to move on to a different tenant, the space is essentially being taken from them. They may need to start over too, and that costs them considerable time and money.
  • The broker works out the deal, invests time, effort and expertise, only to see the deal collapse. Often the landlord or tenant will get frustrated at the broker, who cannot change the situation.
We’ve got a delay—what happens now?

Let’s play this out in a real-world situation. NAI Elliott has a franchisee tenant that is required to select a site and open for business by the end of 2023. A lease agreement was negotiated and signed in July of 2023, providing ample time for construction and store opening preparations before the required deadline. But now, the landlord’s contractor can’t get the materials needed for the agreed-upon tenant improvement work until February of 2024. This, even though the landlord paid a large fee to expedite the project/materials!

So now it’s chicken; who will give ground to make it work? The franchise corporate office isn’t happy with the delay because the tenant has an agreement to start paying franchise fees in January. The tenant had to explain the situation to them and ask for mercy. The landlord is already out an expediting fee and is not going to be getting rent anytime soon. Everyone is impacted.

In this case, the franchise has agreed to extend its timeline to begin receiving fees, and the landlord and tenant are waiting out the delay. But it’s bleeding money from all parties involved.

The best strategy is having the best team

So, what can you do to successfully navigate this obstacle course?

The baseline is that you should have a team beside you that truly understands the potential pitfalls, as well as the best ways to avoid or minimize them. A top-notch broker and experienced contractors are the best allies for a successful new lease. A good broker will ensure everyone involved has realistic expectations and understands the potential delays. A good contractor will have well-established vendor connections and know how to get things done under duress.

On a more specific level, you should acknowledge that the problem is there, and build it into your planning timeline. More and more, we’re inserting language into lease agreements like “due diligence” and “as soon as possible” instead of deadlines. Right now, trying to hit targeted dates is like playing darts blindfolded.

There’s no silver-bullet, quick fix for this. The supply chain should eventually return to normal. And we should all be looking for ways to strategically apply pressure for cities to improve the permitting process. In the meantime, pick your team carefully, know what you’re facing and be prepared to be flexible.

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© 2022 NAI Elliott - All Rights Reserved

© 2022 NAI Elliott - All Rights Reserved


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