Tenant Improvement Allowance

Often, commercial space is either an empty shell, or previously occupied space that needs significant construction work to make it usable for the tenant’s specific purpose.  This is where requesting a tenant improvement allowance from the landlord comes in.  A tenant improvement allowance is an agreement by the landlord to either pay a lump sum or reimburse the tenant for some or all of the construction costs needed to improve the space. 

What to Expect:

Typically, the amount of the tenant allowance is stated a specific dollar amount per square foot of space.  The tenant can use the funds for construction and professional (architect fees), but not on other needs such as furniture or equipment.

Most landlords require the tenant pay for the build-out and will then reimburse those costs either as the construction progresses, or once the construction is completed.  Therefore, it is important for tenants to understand that these are funds they need to have on-hand; the landlord very rarely agrees to front these costs.  Tenants should analyze whether they have adequate cash flow to pay contractors during the project, prior to reimbursement from the landlord.   

What Can Tenant Use the Funds For? 

Tenant Improvements are defined by the terms of the lease, and typically include any addition, alteration or improvement to the leased premises.  Tenant improvements are concerned primarily with interior improvements and changes, but can include certain exterior improvements (such as building or improving patio space). 

How Much Will Construction Cost?

 To know how much to budget for construction costs, a tenant will need to inspect the space, survey the premises and determine how much of the work the landlord is willing to do themselves.  Costs will also be determined by the rates charged by construction professionals in the region, and then-current materials costs.  At a minimum, tenants should expect to pay $30 per square foot for a build-out, in most cases.  The biggest mistake tenants make is underestimating what the total cost will be.  A broker may give you an idea of the build-out cost, but the figure they give will almost always omit fees you will also incur, which can add up to 10 or 20% of the total construction budget. Tenants should do a through analysis of total costs themselves.   

How Much Will Landlords Give for TI Allowance?  

Providing a large tenant allowance is risky for landlords.  How likely will the tenant be able to pay rent for the duration of the lease?  If the tenant breaks the lease, will the tenant be able to pay the tenant improvement allowance back?  Most landlords analyze a few factors in determining the amount they are willing to provide: 

The creditworthiness of the tenant (and its individual owners).  The landlord will look at the credit score of the business and that of its owners, how long the business has been in operation, and its financial history.

The condition of the space.  If the space is old and run-down, and thus not very marketable, the landlord is more likely to provide a larger tenant improvement allowance, in order to entice a renter to the space.

Rental market—is there a higher demand for commercial space than there is supply?  If so, the landlord can afford to be less generous in their tenant improvement allowance.  On the other hand, if there is a plethora of commercial space available, the landlord may have no choice but to offer a higher tenant improvement allowance if it hopes to rent its space in a competitive market.

The financial resources of the landlord.  Large corporate landlords are more likely to have the financial means to provide a hefty tenant improvement allowance than a smaller landlord. 

What Can the Tenant Improvement Funds Be Used For?

The tenant improvement allowance may be used for “leasehold improvements,” and the definition can vary from lease to lease.  Leasehold improvements often include such things as flooring, walls, doors, lighting, drywall.  It is important to review the lease definition, to ensure that it includes other costs that may be incurred, such as building permit fees and professional fees for architects and engineers. 

Unfortunately the tenant improvement allowance does not typically cover furniture, trade fixtures or equipment.

Can Tenant Use Contractors of Their Choice? 

Tenant should request that the tenant improvement allowance can be spent on contractors of their choosing.   Most landlords want to approve of the contractors chosne, to ensure quality work.  However, if the lease goes further and requires the tenant to use the landlord’s contractors, this can be very costly.  Many landlords have expensive contractors, and tenants do not want to have to pay higher costs than necessary, especially at a start-up phase when funds may be tight. 

What Happens to if Tenant Defaults?

The tenant improvement allowance is conditioned upon faithful performance of the lease.  This means that if the business fails, the tenant can no longer pay rent for any reason, or tenant otherwise violates the lease, the lease provisions will require that tenant pay back the amount of the tenant improvement allowance.

What Happens at End of Lease? 

Many leases have a “make good” clause, requiring the tenant to restore the premises to a base building condition (otherwise known as a concrete shell, or “raw” condition) at the expiration of the lease.  We recommend negotiating for the removal of this clause, as it can be an expensive endeavor and one tenants do not want to undertake at the end of the lease.