In real estate, it's possible to lease some commercial buildings in what's known as "shell condition," meaning that the space is largely unfinished. However, if you're thinking of going this route for your retail or office space, there are some major considerations you'll have to keep in mind. To that end, below is a guide to shell condition, including what it is and the benefits and disadvantages of leasing this type of space. Read on below to learn whether this might be a good investment for you.
What is shell condition in commercial real estate?
In commercial real estate, the term "shell condition" refers to the interior condition of the space when a new tenant takes over a lease. Typically, this type of condition denotes that the building's construction elements have been completed but that there are few, if any, finishes. While there can be some variances in what's included in a building that's in shell condition, you can at least expect it to include:
- A roof.
- Four exterior walls.
- An unfinished concrete floor.
Usually, however, the following elements will not be included:
- HVAC system.
- Interior walls.
What are the different types of shell space?
That said, there are a few different types of shell condition that you might encounter in lease negotiations. As you might expect, they all have slightly different connotations in terms of the various construction elements that will be included. As either a tenant or a landlord, you'll want to take the time to familiarize yourself with them all so you can negotiate which of these multiple conditions will work best for you.
A building that is in cold shell condition is in the barest condition available. A cold shell is effectively a skeleton of the building. It will have no insulation or finishes as well as no true electrical wiring or plumbing. Notably, cold shells are usually bought rather than rented because of the extensive nature of the build-out that would be required in order to make the space habitable.
As the name suggests, a building that's in warm shell condition will typically have at least a partial HVAC system installed and ready for distribution by the eventual tenant. In some cases, these spaces may also have a fully functioning core, including electrical closets, mechanical rooms, lobbies, and restrooms.
On the other hand, a dark shell connotes that there is no lighting or electrical wiring installed in the space. In most cases, the phrase "dark shell condition" will be combined with "cold shell condition" and the space will be described as "cold dark shell condition."
Bare shell condition is where the building's condition starts to become more immediately inhabitable. With a bare shell building, you could expect to see plastered walls, basic flooring, and finished common spaces like bathrooms or kitchens. This condition is sometimes also referred to as a "ready-to-fit-in" property.
Vanilla shell is the most finished of the multiple conditions that can be negotiated. Typically, this type of space has exterior walls that have been finished with drywall, basic flooring and ceilings, lighting, plumbing, and basic fixtures.
What are the benefits of leasing a space in shell condition?
It offers flexibility and initial cost savings for the tenant
From a tenant perspective, the biggest benefit of leasing a space in shell condition is that it offers the flexibility for the tenant to design the space in whatever way they see fit. If, for example, the tenant has space requirements that are much different than those of a traditional retail space or office space, they will have the ability to customize the space to fit their needs.
Many tenants also consider taking space that's in shell condition because the rents are often lower than a comparable building that's already been fully finished. However, if you're thinking of going this route, it's important to budget your construction costs carefully and negotiate your tenant improvement allowance to that effect.
It often provides ease and longevity for the landlord
On the other hand, from a landlord's perspective, the biggest benefit of leasing out a space that's in shell condition is ease. Since there is less infrastructure in the building, there's less to be maintained and less responsibility that will ultimately fall on the landlord's shoulders. If, for example, the HVAC system is included in the tenant's build-out, odds are it would also become the tenant's responsibility to maintain.
In addition, while nothing is guaranteed, there's also the possibility that leasing a building in shell condition will also lead to the tenant staying in the lease longer than they might otherwise. Put simply, if a tenant invests time and money into completing a built-out to customize the space to fit their needs, it's unlikely they'll be looking to move as soon as their lease is up for renewal.
What considerations come with a building in shell condition?
Building out shell space can be costly and time-consuming for the tenant
It almost goes without saying that leasing a space that is in shell condition is a commitment for the tenant. For starters, doing a custom build-out of the space will undoubtedly be costly. Plus, if the construction costs end up being more than the amount of your tenant improvement allowance, your company will ultimately be responsible for footing the bill.
In addition, it can also be time-consuming. By leasing this type of building, you're essentially agreeing to wait to move into the space until you have any necessary renovations completed. While everyone always hopes renovations will go smoothly, there could be bumps in the road or construction delays. If your goal is to move into your new space as quickly as possible, you'll likely be better off looking at finished properties.
These buildings can be harder to rent out for the landlord
Ultimately, when you're looking to rent out shell space, you're in the market for a specialty tenant. Only certain tenants are going to be willing to deal with the hassle of a renovation. With that said, your property may be on the market longer than some other options that offer the ease and security of fully finished space.
The bottom line
When negotiating a commercial real estate lease, it's important to consider what condition the building will be in when your lease starts as well as the exit status. If you're considering leasing a building that's currently in shell condition, there are even more details to consider. For one, you should think carefully about what type of shell condition is being offered. For another, you should do your best to negotiate a tenant improvement allowance amount that will cover the scope of the work. Use this post as a guide to help you determine whether leasing shell condition is right for you.
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