How does a tenant improvement allowance work?
Tenant improvement agreements benefit a single space. In a building with multiple units for lease, the costs incurred as TI will only benefit one tenant. If there are renovations or construction to a common hallway, lobby, community break room, or conference room, those are considered building improvements. They benefit all tenants and the building owner.
While tenant improvements benefit the tenant in the short term, there is no benefit or increase in value for the tenant when vacating the space. Improvements made during the construction or renovation period do not belong to the tenant, and the cost of the improvements is not recoverable. Tenants should consider the length of the lease term when determining the value of TI.
Who pays for tenant improvements?
Considering the benefits of negotiating tenant improvements into a commercial lease is impossible without considering finances. Most often, tenants pay the construction costs and are reimbursed by the landlord when the work is complete. In those cases, the reimbursement may be a lump sum or divided into credits that will reduce the tenant’s rent for several months.
Landlords will not typically release any funds to a tenant until they have provided proof of payment to their contractor and a lien waiver releasing the property from construction lien liabilities. There are also commercial lease agreements where the landlord pays the tenant improvement allowances directly to the contractor.
Ultimately, payment responsibility depends on whether the improvements are tenant-controlled or landlord-controlled.
Landlord-Controlled Tenant Improvement Allowances
In landlord-controlled tenant improvement allowances, the landlord carries out architectural and construction services. Specifications for the work will include the landlord’s or building’s standard options for electrical access, colors, styles, window treatments, and other planned changes.
The options provided by the landlord are generally in line with their financial health and the class and appearance of the building. But the tenant can negotiate upgrades before the project commences. Landlord-controlled TI provides tenants with a turn-key process, handing over a finished product at the time of possession.
Tenants often prefer a landlord-controlled or turn-key process because of the landlord’s experience with similar projects, building knowledge, and relationships with contractors and vendors. Landlords will complete the tenant improvement work within the budgeted TI costs outlined in the lease agreement.
If the project exceeds the original budget, the landlord is responsible for covering overages. However, if it’s possible to complete an acceptable project for less than the TIA, the landlord does not turn the excess funds over to the tenant.
Tenant-Controlled TI
In a tenant-controlled TI agreement, the tenant has direct control over the project, giving them a higher level of engagement at every step. Most often, with tenant-controlled TI, the tenant finds their architect and contractors, but landlords are often willing to recommend vendors.
While the architect chosen by the tenant creates the project plans, they usually require landlord approval. The landlord also obtains proper permits before construction begins.
In tenant-controlled TI projects, tenants often contract a project management firm to oversee the entire project. A project manager will work with the contractors and may communicate with the landlord on approvals and updates. Any changes in the originally approved plans must be submitted to the landlord to ensure no issue or delay with the reimbursement agreement.
The benefits of tenant-controlled TI include complete control of the project and the ability to maximize the use of budgeted funds. Still, this type of improvement project requires the tenant to provide a substantial amount of capital upfront.
