Tenant Improvement Work in Japan – Part 1: A Work, B Work, C Work

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Toranomon Hills Business Tower (left foreground, under construction), and Toranomon Hills Mori Tower (right background), two Class 1 office buildings in Tokyo, Japan in which my firm is currently managing construction work.

“Any fool can write a book and most of them are doing it; but it takes brains to build a house.” 

Charles Fletcher Lummis

This article is not focused directly on woodworking or woodworking tools per se, but rather on how to go about leasing space in Japan, and contracting for construction in that space. The wood and tools come afterwards.

I have never seen the subject of Tenant Improvements (or Tenant Fit-out, as it is called in some countries) addressed in writing outside of real estate dealings and construction projects in Japan, and never on the internet. It will no doubt sound like gibberish to many, but those involved in the real estate or commercial construction industries may find it interesting and maybe even profitable.

You should find it especially interesting if you anticipate leasing space in a building in Japan, or doing construction work in a leased space here. This little bit of basic insider knowledge could make you look like a genius.

You Don’t Know What You Don’t Know

Too often I have worked with people and companies, who shall remain nameless, that made planning decisions without the insight described below. The results were sometimes painful.

The most jarring incidents I have seen occurred with people and companies accustomed to real estate leasing and construction projects in their own countries, but who are willfully ignorant of how things are done here in Japan, and insist that the knowledge and experience they possess is applicable without significant adaptation. In response to corporate pressure, and based on a poor understanding of local realities, these lost souls plan the process to fit their abilities confident they will be able to manipulate the Landlord and contractors through a combination of their devastating charm, superhuman negotiation skills, and the leverage afforded by their company’s wealth and fame. In a leasing market of 96% occupancy, such people frequently wake up to find reality kneeling on their neck while carving tasteless limericks into their forehead.

The most pitiful prospective tenants I have seen came to Tokyo from Hong Kong and Singapore. They sent younger employees to handle the leasing, always with good English-language abilities, but no experience outside their own country or mainland China, where they had only dealt with unsophisticated and hungry brokers, consultants, and contractors to whom they could dictate terms and conditions. Absolutely convinced the Hong Kong or Singapore way of doing things is the only way, they waste time, money and goodwill banging their heads against a stone wall never realizing that Japan has an advanced real estate and construction industry with many companies hundreds of years old and possessing technical capabilities few, if any, American or European companies can even think to match.

Delays, budget overruns, embarrassment, pattern baldness, and sudden employment changes ensue.

I prefer to avoid all that drama. How about you?

The Tokyo Office Leasing Market

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A commercial office building under construction. The completed building is of exceptionally high quality.

High unit lease rates and the tricks of the trade described below have made owning and leasing out office/retail space in a Class 1 office building in Tokyo one of the world’s most profitable, risk-free, and steady investments.

You won’t see this fact written about in financial publications, however, because it’s small club that’s difficult to join and with few opportunities for foreign financial consultants to make a profit in the fly’s lifespan time-window they allow for investments to bear fruit. But there are a few savvy real estate investors outside of Japan who know the value of owning the right building in the right place in a Japanese metropolitan area and wish they could get a piece of it.

A handful of foreign companies and investors have succeeded here, especially in the hospitality industry, but it is a long row that few non-Japanese companies have the patience or connections to successfully hoe.

All of the terms mentioned in this post are related to a tenant space (usually office or retail) leased in buildings in one of Japan’s major cities, and constructing the improvements (aka “tenant improvements,” “TI’s,” or “tenant fit-out”) needed to make the space usable.

So let’s dive in and paddle like a duck in an alligator farm.

A Work

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A jobsite in Tokyo with extensive drilled-piling work underway. 12 cranes and 6 drill rigs are working concurrently. 600 trucks entered and left the jobsite daily during this foundation work.

“A Work” (short for “Category A Work”) is a contractual term in Japan which refers to construction work performed directly on the “Base Building” on behalf of a Tenant in the building. This type of construction work does not, however, come into play until the building’s construction is complete and the terms of a tenant lease agreement are being negotiated.

“A Work” typically includes any modifications to the base building’s structure, core & shell, mechanical, electrical and plumbing systems, elevators, common areas, etc. If you need to cut holes in the floor slabs for stairs between multiple floors you will lease, or need to add duct space or pipe shafts for your rooftop equipment for instance, it will be A Work.

Owners of high-quality buildings in metropolitan areas are understandably keen to preserve their investment and the income it produces and so will always have their designated contractor perform A Work at their direction but at the Tenant’s expense. This is an important point to keep in mind.

You will have no opportunity to competitively bid A Work, so save yourself the embarrassment of insisting, being rebuffed, and having to explain a strategic error to your board of directors.

Be aware that if you intend to propose to the building Owner or Landlord that the modifications you require will improve or upgrade the base building, and therefore the cost should either be borne or supplemented by them, you will need to conclude those negotiations before you sign the lease, while you have leverage, or the entire cost will be your responsibility.

Please note that it will be your contractual obligation to pay for restoring the building to its original condition, whether the Owner/Landlord actually does it or not, and even if that means downgrading the building. The cost, for instance, of removing/restoring a stairway between floors frequently costs more than the original construction itself. Ouch is right.

We will discuss “Restoration” in a future post in this series.

B Work

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Electrical work underway.

“B Work” is another contractual term you will need to understand. It refers to tenant improvements (aka “tenant fit-out”) “connected” to the base building.

B Work typically includes all mechanical, electrical, lighting, plumbing, HVAC, ductwork, fire life-safety work (fire sprinklers, gas fire suppression systems, fire alarms and emergency lighting, etc), partitions, ceilings, OA floors (raised floors) wall finishes, most floor finishes, blinds and PA systems to be constructed or installed inside the lease space, as well as Tenant-requested BMS systems, emergency generators, chillers and heat exchangers required to service the tenant’s equipment.

Often millwork (cabinets), kitchen, pantries, and sometimes even system furniture to be located within the tenant’s leased space are included in B Work too. The old, bitter joke is that if you turn the building upside down and shake it, everything that doesn’t fall off is either A or B Work. Not a lot left.

B Work too is almost always performed by the Owner/Landlord’s designated contractor(s), often the same ones that constructed the building originally, at highly inflated prices. You won’t see it as line item in the B Work contractor’s cost estimate, but the Owner’s and management company’s hefty cuts are included.

Here is a critical point to grasp: Competitive bidding is not an option for B Work. Your company’s strict procurement rules will therefore be irrelevant, so best to get your procurement department on-board early. But don’t worry, this isn’t the only standard “carved-in-stone” rule your company will need to adapt.

The Tenant normally signs a construction contract directly with the designated B Work contractor(s) but has very little leverage to control construction costs. The Owner/Landlord has no motivation to see these construction costs reduced, you see, and so will not aid you in reducing them. Do you see where this is going?

C Work

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The third type of Work we will discuss in this article is called “C Work.” It includes everything the Tenant wants constructed besides A Work and B Work, including carpet tiles, Audio-visual equipment, IT cabling and servers, Telecom, UPS, security systems (card readers, security sensors and cameras inside tenant spaces) millwork (sometimes), specialty lighting and sound systems, AV systems, and loose furniture. Usually system furniture too, but not always.

Sometimes C Work includes interior partitions, such as glass or metal partitions, that are installed between the OA floor and the ceiling and do not connect directly with the floor slab or overhead structure. This item is often a good opportunity to save costs and is worth negotiating thoroughly before signing any lease. More on this in the “Demarcation Table” section below.

Unlike A and B Work, a Tenant can directly perform C Work using qualified licensed contractors they select. Bidding is entirely possible and construction costs are typically at market prices much less than A Work and B Work, so compared to A Work and B Work, cost savings can be realized.

On the other hand, if you are in a dreadful hurry and/or can’t be bothered to deal with producing drawings and hiring contractors, then asking the B Work contractor to execute your C Work design/build is an excellent, but expensive way to simplify and expedite the process.

You will want to prepare well and plan your lease negotiation schedule to take advantage of the local knowledge your PM team possesses to move as much of A Work and B Work into the C Work column of the Demarcation Table as possible.

The Demarcation Table

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As you probably deduced from my vague definitions of A, B and C Work above, the limits of each type of construction work vary from city to city, landlord to landlord, and from building to building. Sometimes they are negotiable, sometimes not.

The “Demarcation Table,” or more correctly “Construction Work Demarcation Table” 工事区分表 is a document that becomes part of the lease agreement and lists the items of construction work included in A, B, and C Work. As the Tenant, you or your agent must negotiate this document along with the lease.

Careless people sometimes leave this discussion for after the lease agreement, but a wise Tenant will know before beginning negotiations what construction work they will need, what concessions they want, and the likely unit prices they will be charged for construction so that negotiations will go smoothly, the best deal can be obtained, and buyer’s remorse can be avoided.

Having a knowledgeable leasing agent and Project Management team on your side during this critical process will make the process quicker and the results more economical.

Allow me to share a few examples of how to handle the Demarcation Table to your benefit during Lease Agreement negotiations.

For instance, the Landlord may not be willing to discount your lease as much as you like, but if you are prepared in-advance, you may be able to convince him to tweak the demarcation table so some expensive construction items, and/or items you want your contractor to perform, are shifted from B Work to C Work allowing you more control at less cost.

Or perhaps you need to install a backup generator to service your IT system. You will need space to install it, and provisions for a fuel tank, fuel lines, and exhaust and cable shafts/ducts. If you negotiate carefully and early, you may be able to get the space for free, or at a discount. After the lease is signed, however, fat chance.

After they perform their electrical load calculations, some tenants are surprised to learn that, while the building overall has adequate power for their needs as confirmed during due diligence, they will need to install a transformer or three to step the power up or down or change the phasing to meet their power requirements. Labs, cleanrooms, kitchens, and video studios, for example, use a lot of juice.

Transformers often must be mounted outside, perhaps on a balcony or more likely on the building’s roof. Transformers, switchgear and electrical panels are definitely “long-lead items” that take months to fabricate/procure, as are the steel electrical cabinets to house them. If you know you will need this equipment you can adjust your schedule and budget early, and negotiate concessions from the landlord for space, and access. But if you wait until the lease is already signed, your leverage will be gone, baby, gone.

Why does all this matter, you ask? It matters because once you sign the lease, you are committed and have no choice but to pay whatever price the Landlord and his contractor want to charge you for A Work and B Work, and comply with their schedule. There are ways to minimize the pain, but on your own you won’t have the relationships, the data, the local experience, or the language skills to make meaningful headway. Conversely, you most definitely will have the ability to increase the costs of A Work and B Work by creating hard feelings with the Landlord through confrontational Trumpian-style negotiation techniques.

Don’t push or allow your real estate leasing representative to negotiate your lease in a rude, condescending, or pushy manner because, if he does, the Landlord will make you pay for it ten times over later in cashy money.

There are many other details related to A work, B Work and C Work you need to identify through due diligence, engineering consultation, cost estimating, scheduling and negotiations. Experience in the locale and possessing good relations with the Landlord, contractors and consultants are critical. You will need a good Project Manager with local experience to ensure this work gets done quickly and completely, unless, that is, you enjoy explaining budget overruns, schedule delays, and inadequate facilities to your boss or board of directors.

Building Permits

In many countries, the process of obtaining building permits/approvals is a huge uncertainty, and sometimes a crap-shoot that delays schedules and wastes huge amounts of time and money. In Japan’s metropolitan areas, however, building permits are typically not required for tenant inprovements. There typically aren’t even any inspections by the building department.

The one sure exception to this general rule is the Fire Department, who will need to review the fire sprinkler and other fire/life-safety drawings the B Work contractor will prepare and submit to the Fire Department. The Fire Department will also insist on inspecting the building at the completion of construction, but before occupation. This is a “hard stop” to construction that cannot be avoided, and sometimes consumes a week or more. Careful preparation by a respected B Work contractor can accelerate this process.

As the Tenant, you have no role in this process other than to stay out of the way.

If your legal beagles get their panties in a knot out of concern about potential non-compliance of the Work with local codes and regulations, tell them to take a handful of Xanax with a cold brew and just chill because the general contractor has full legal responsibility for defective and/or non-compliant work. I have never seen permits or approvals become a problem.

You would be wise, however, to have your Project Management team in Japan perform regular inspections and report to you until the construction is complete and the project receives occupancy permission from the Fire Department.

In the next post in this series we will examine the design process for a tenant fit-out project in Japan.

YMHOS

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2 thoughts on “Tenant Improvement Work in Japan – Part 1: A Work, B Work, C Work

  1. Just imagine, no building permits or county inspections! I’m not in the construction business, but I’ve heard so many stories of delays, expense, arbitrary pettiness and rip-it-out, do-it-over because of the building inspection system. Tears of aching jealousy may be dimming the eyes of some of your readers.

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    1. Tim: The City has the right to conduct inspections, but not the obligation. They also have no liability. Talking about tenant improvements here, not new construction or even a major remodeling of a building. On the other hand, even of you have an architect/engineer producing drawings, the GC has FULL LIABILITY for compliance with codes and regulations, most of which are identical throughout the country. Impossible to imagine in the USA where every State and every County and every City has their own rules, many of which contradict. And public employees. The Japanese way removes a tremendous amount of uncertainty, eliminates nearly all permit-related delays, and helps to keep things under-budget. And the best thing is that single-source responsibility denies lawyers a profitable foothold in the construction industry other than contractual/payment matters. The downside is that to cover this liability, construction costs tend to be higher, but I think the reduced waste and legal fraud more than makes up for this.
      The Fire Department is the wild card in the deck. They have absolute authority, and their interpretation of code/regulations is final. This means the GC has to be thorough. Using a GC for A, B, C work with a good reputation with the local Fire Department is important, because sometimes the final inspection will be waived, and if not, it will go smoother with less rework. A bad, untrustworthy GC will always cause delays.
      The worst place I have worked regarding permits and inspections was San Francisco. Valiant obstructionism. Extravagant demands. Unimaginable incompetence. Absolute irresponsibility. Breath-taking sloth. Every day was an adventure.

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