Physical space is poised for a dramatic makeover post pandemic, as the commercial real estate market begins to recover. A recent report from GlobeSt.com notes that “one-size-fits-all solutions are a thing of the past as office users test new models, modify existing programs, and prioritize flexibility and choice in their space planning considerations.” Tenant improvement allowances have always been a central negotiating point between landlords and tenants. In the upcoming years, that’s going to be more true than ever before.
In this article, we’ll look at how tenant improvement allowances work and what to expect when negotiating a tenant improvement allowance.
What are Tenant Improvement Allowances?
A tenant improvement allowance – also known as a TI, TA, TIA, fit out, or build out allowance – is an incentive landlord and tenant often negotiate as part of the commercial lease agreement in a building for rent. TIs are normally found by tenants looking for an office or retail lease .
TI allowances provide funds or a credit to the tenant to build out and customize leased space. Landlords offer a tenant improvement allowance to entice good tenants to sign a lease for space in their building.
The tenant improvement allowance does not technically have to be repaid by the tenant, because it’s an ‘allowance.’ However, landlords who offer TIs will usually seek to recover the cost of the allowance they’ve provided by factoring the tenant improvement expense into base rent or extending the expiration date of the lease.
What Does a TI Allowance Include?
The TI allowance amount and the details of how a tenant can use that improvement allowance are described in the lease. Since the landlord is giving the tenant money to improve their leased space , the landlord usually is only willing to pay for items that increase the property’s value.
TI costs are typically categorized as hard costs that a landlord will pay for – because they increase the building value – or soft costs, which are the tenant’s responsibility.
Hard costs included in a TI allowance
Hard costs paid for by the landlord may include:
- Interior framing and walls
- Doors and windows
- Conference room build-out
- Installation of bathrooms or kitchen area
- HVAC, ductwork, electrical, conduits, plumbing, hardware
- Paint, carpeting, and flooring
Soft costs not included in a TI allowance
Soft costs usually paid for by the tenant may include:
- Window coverings
- Furniture and fixtures
- Electronic equipment
- Cabling for data
- Interior or exterior signage
- Moving expenses
How to Calculate a Tenant Improvement Allowance
A tenant improvement allowance can be calculated as a lump sum or stated as a dollar per square foot amount.
The amount of a TI varies based on the supply and demand of space for lease in the submarket, credit quality of the tenant, amount of space being leased and the term of the lease, and the space’s current condition (built-out versus shell space).
For example, if a tenant is leasing a 5,000 square foot newly built office suite and the negotiated TI is $25 per square foot, the TI allowance would be $125,000.
Note that the tenant will need to pay for improvements upfront in most cases, then be reimbursed by the landlord after project completion, which includes proof of receipts paid, removal of any contractor’s liens, and code inspections.
In some instances, a landlord with an in-house construction team may be willing to do the TIs for the tenant. However, tenants should receive at least two estimates from outside contractors before agreeing to the pricing proposal offered by the landlord.
Who Controls TIs?
In some cases, the landlord will control and take care of tenant improvement work, particularly for smaller spaces or minimal TIs. The tenant advantage is time savings. A landlord also benefits by controlling the TIs, since they can maintain control over improvements and overall cost.
On the other hand tenants, who have specific needs or want to ensure their company’s image is reflected in the build-out, may choose to hire their own general contractor to complete the TIs.
Most landlords and commercial property managers will be able to refer trusted contractors. Tenants should expect to have the TI plan approved by the landlord and be able to provide building owners with periodic updates on the tenant improvement process.
Is a Tenant Improvement Allowance Negotiable?
A tenant improvement allowance is usually negotiable, depending on the quality of the tenant, the amount of available space for lease in the market, and the conditions and length of the lease. A five or ten-year lease, for example, provides the landlord with more years to recover the cost of the TIs through rental income and rent increases.
To negotiate favorable TIs with a landlord, the tenant should be willing to provide several years of tax returns and financial statements to prove their creditworthiness.
The timing of tenant TI repayment may also be negotiable.
Usually, a tenant will need to wait for all tenant improvements to be completed before receiving landlord reimbursement. In some cases however, a tenant may be able to negotiate landlord repayment on a predetermined basis to help with the cash flow needed to cover TI costs.
Alternatives to TIs
Paying out of pocket for TIs and waiting to be reimbursed may not be the right choice for every tenant. Start-up businesses often do not have enough free cash flow and small business owners may not have the time and expertise to oversee a large tenant improvement project. In cases such as these, there are two good alternatives to TIs:
- Look for turn-key, move-in-ready space that requires only basic improvements such as reflooring or painting. Projects like these can be easily completed by a handyman or vendor selling the materials.
- Rent abatements are another alternative to TIs. Tenants who have the money and experience to oversee a TI project may be more concerned with the timing of cash flows. A rent abatement offers several months of free rent at the beginning of the lease. Tenants can avoid having rent payment and tenant improvement costs overlap.
A tenant improvement allowance is an incentive landlords use to attract tenants, especially in markets when there is more supply than demand for office and retail space. Offering a TI can benefit both landlords and tenants, but several variables are considered when negotiating a tenant improvement allowance.
Knowing how TIs work, building owners and occupiers can create incentives that help space get leased to the most qualified tenants.
On the hunt for office properties? Check out offices for rent on Crexi.