Image credits: MacRo Commercial Real Estate
All commercial properties that are about to be leased to tenants have a certain initial condition in which they are handed over. It is common for building owners to lease their commercial spaces in a shell condition, and you will come across several variations of the term “shell” during your hunt for the right building type. In commercial real estate, a shell is the first stage of a leasable building’s life cycle, and it is exactly what the name suggests: an empty space with an outer cover. Shell-type buildings just have the basic exterior structure like a roof, floor slabs, and outer walls. Therefore, shell leases deliver your chosen building in its bare-minimum condition. There is a whole spectrum of different shell types as well, ranging from cold and warm to vanilla, grey and dark – which can be quite confusing to fully understand. To make things simple, here is an analysis of the two most basic types of building shells: a cold dark shell and a warm dark shell. Both of these are typically the origins of a building and are ready to receive their first-ever layer of improvements for tenant occupancy.
What exactly is a shell condition?
A building shell is simply a 4-walled empty structure that is about to be improved and occupied for the first time.
It refers to a building’s most basic appearance in which it can be presented to visiting tenants – because prior to the shell condition, there will be “Caution! Area Under Construction” safety signs barricading the site! Such a commercial building includes just the 4 main exterior walls, a roof, and a floor slab. There are no usable features inside, so you will not find any HVAC, lighting, finished ceilings, utilities, elevators, sprinklers, etc. It is an unfinished space available for tenants who want to customize the build-out process right from the start. Shell spaces normally exist as first-generation buildings that have never been improved, occupied, or updated before. To understand how move-in friendly they are, commercial experts refer to various shell types to distinguish between the different options, as discussed below.
A building’s initial state decides your build-out budget, move-in time, and allowance scope to fund your project. In commercial real estate, building owners and tenants often have different views on what a shell condition entails, which is why it is important to clarify the building condition that will be delivered to you for leasing. This should be stated clearly in the lease to avoid disputes later on. In general, a building can be:
- a dark shell space
- cold dark shell
- warm dark shell
- a vanilla shell space
- warm vanilla shell
Dark shell spaces have no lights – hence the darkness! They also lack any functional elements like electricity, plumbing, HVAC, ductwork, painted walls, or tiles. In contrast, vanilla shells go a step above and include some basic interior lighting to illuminate the space. These are 2 major shell types from which different variations are derived. Since the shell hierarchy can extend depending on what you want, it will be easier to focus only on dark shells first as they are the main starting points of any commercial building. You might wonder why anyone would choose to lease a commercial property in its dark shell condition. The answer is that these dark shells provide maximum freedom to customize the interior space however you like, which is a huge incentive if you are planning to stay for a comfortably long time.
What is a cold dark shell?
Before discussing warm dark shells, it will help to first understand the preceding stage of cold dark shells. Within the shell spectrum, the word “cold” refers to a lack of heating within the space, making it cold to be in. This means that a cold dark shell has no HVAC framework, lighting, finished walls, proper flooring, elevators, and utilities – so it is literally cold and dark as the name suggests. It is the first official bare-minimum and leasable building condition available to tenants. The cold dark shell is what we like to call a building’s rock-bottom level, as it really is the lowest possible point and can only be improved from here onwards. For this reason, you will often hear commercial audiences use terms like “bare bones” and “building skeleton” to describe such an unfinished space.
Reasons to lease
Commercial tenants who want the complete freedom to build out their leased property with custom options will choose a cold dark shell condition. Since no tenant improvements have been made so far, you have the liberty to micromanage every small detail of your build-out project. You can choose exactly what type of HVAC installations and units will be used, which high-quality finishes will be added, how many custom lights will be installed, and so on. The shell space will first be brought to a livable standard by adding the main functionality frameworks like HVAC, electricity, plumbing, doors, windows, tiles, and other mechanical elements. You can then incorporate design aspects before installing the furniture and fixtures, after which the building will be ready for occupancy.
This transformation naturally demands more time and budget, so it is something you should only consider based on your current commercial standpoint. Investing in such a tenant-oriented build-out is best for long-term leases that can give all of this hard work the time it needs to be considered worthwhile. It does not make sense to lease a cold dark shell, add all the hefty improvements, and then leave the building within a year in search of a new place. So, the longer you intend to stay (say 5 years and above), the more your investment will pay off, and the more you can enjoy your detailed customizations.
Cold dark shells come with a range of benefits for both tenants and building owners. For tenants, there is a maximum scope for build-out customization that makes such a building type ideal for long-term occupancy – as you get a space that is tailor-built just for your business. The higher improvement costs will also convert into lower monthly rents, so this is again very promising for longer leases. Cold dark shells have more chances of securing greater tenant improvement allowances from the building owner. This is because the changes you add will stay behind even after you leave at the end of your term, so the owner now has a finished space that is more likely to be rented by someone looking for a second-generation building to occupy soon. As a result, the owner will be more inclined to fund your build-out if this will ensure consecutive leases in the future.
For building owners, leasing their commercial property in a cold dark shell condition means that they will not suffer the risk of wasted construction in case the tenant does not like the improvements. This avoids the headache of incurring demolitions to tear down the added improvements and reverse the condition back to a cold dark shell. For example, if the owner stepped up the cold dark shell by adding finished floors and walls, a potential medical tenant might ask to open them up in order to accommodate specialized, technical frameworks for clinics, which will be a huge loss and extra work on the owner’s part. Since the building already exists at a bare-minimum level, the initial construction costs will be quite low for the owner, so this is also very financially convenient. In addition, the owner can target a wider pool of office, retail, medical, recreational, and hospitality tenants because the existing space can be customized by all kinds of commercial clients. This increases the chances of finding a suitable, long-term tenant, as only serious tenants aiming to stay for many years will choose to work so hard in building out a leased space – translation: regular rents for the owner!
Such a detailed level of improvements in a cold dark shell requires a strong commitment on the tenant’s part. If for any reason, you have to relocate earlier than expected, all of your hard work in optimizing the shell condition will be wasted. This also means that you will have to plan and finance these retrofits all over again in the next building you are about to lease.
Image credits: Austin Tenant Advisors
What is a warm dark shell?
As discussed above, cold dark shells are ideal for sheer customization purposes and tend to be quite expensive, so they might not work for everyone. Warm dark shells are the next stage after a cold dark shell condition. These buildings started out as cold dark shells and are now promoted to the warm dark shell level. They alleviate some of the build-out difficulty by giving you a space that can be “heated”. The interior is equipped with some HVAC elements and the basic utilities to operate them, which crosses off HVAC functions from your build-out list. A warm dark shell will usually have a connected HVAC unit and ductwork ready to go, so while it does have the required electrical connections, the space still lacks lighting and other amenities. You are basically one step closer to moving in at this point. The building is still unfinished and needs to undergo every other improvement apart from HVAC aspects. A warm dark shell build-out will result in a white box space, which is the first completely finished look before the furniture and final touch-ups fill the gaps.
Reasons to lease
If you are not too picky about the type of HVAC units and ductwork installed for your business, you can opt for warm dark shells, as they still offer ample customization options in the rest of the build-out. Another reason to lease such a space is that it saves more time in finishing out the interior, allowing you to move in that much quicker.
If you have a medium lease duration, you might want to choose a warm dark shell over a cold one because you will no longer have to worry about leaving behind an expensive HVAC infrastructure after just a couple of years.
Warm dark shells also offer benefits to both parties. Commercial tenants can benefit from faster move-ins, lower budgets, and fewer build-out complexities. You still have enough freedom to personalize lighting and other technical features, so you can divert your HVAC savings towards top-quality lighting, smart controls, touchless fixtures, custom décor, and other high-end amenities. By providing just one major relief in terms of HVAC, the owner is still playing it safe because every commercial tenant will require a basic HVAC framework anyway. So, there is a reduced risk of wasted construction or repetitions on the owner’s part, as there are no finished walls and flooring that might need to be torn down.
The main downside to leasing a warm dark shell is that while you do incur lower build-out costs per square foot, you will have higher rents to pay compared to cold dark shell tenants. The installed HVAC reduces your build-out costs initially because you are not paying for the HVAC components anymore. However, building owners can charge higher rents either from the beginning or eventually down the road to cover their HVAC contributions. Another drawback is that since you cannot secure higher allowances for warm shells, any exceeding costs outside the total budget will go from your pocket. This is because the lease generally holds you responsible to cover extra costs – unless negotiated differently.
Image credits: Austin Tenant Advisors
Shell leases have their highs and lows within the commercial real estate. It is often very confusing to tell exactly what the given shell type is, as everyone assumes a different meaning for shell spaces. Make sure to always confirm the condition in which your leased building will be delivered to you for the build-out, and this should be mentioned clearly on the lease. Otherwise, you will miss potential benefits like higher allowance scopes, greater customization freedom, and quick move-in times. In the cold vs warm dark shell comparison above, we saw how stepping up one level from the bare minimum can make a world of difference. Just by including HVAC, a warm dark shell can turn the dynamics in unexpected ways like increasing your rent or adding top-notch lighting systems.
It helps to get in touch with professional and licensed commercial contractors who know how to make the best out of a given space. Carefully planned tenant improvements benefit both tenants and building owners, so it is important to find that win-win middle ground. Tenant improvements add value to the commercial property; therefore, it really is your commercial business that brings the building out of its shell!