Searching for commercial real estate is an exciting time for any business owner. Still, after visiting a few available units, you may realize most spaces require some work before they’re ready for your business.
Before you give up on the perfect location, check with the broker or landlord about adding a tenant improvement allowance into the lease.
The tenant improvement allowance, also known as TI or TIA, describes an incentive some landlords offer in the commercial lease of an office, retail, or warehouse space. The allowance outlines the construction costs a landlord is willing to cover in preparation for tenant use and is spelled out in the lease or accompanying amendments.
The scope of work included in TI often includes custom renovations based on the tenant’s needs and covers structural or cosmetic build-out expenses, including labor. Typical improvements include a remodeled floor plan, lighting upgrades, wall demo or construction, countertops, plumbing, paint, and other finishings necessary for the space to be ready for tenant occupancy.
TI does not typically include allowances for furniture, moving expenses, or other start-up costs.
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.
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.
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.
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.
Landlords determine the amount of a tenant improvement allowance by considering many factors, including the length of the lease term, the age and condition of the building, other occupants, the size and condition of the unit, and market conditions.
The tenant improvement allowance is usually calculated and presented in dollars per rentable square foot (RSF). For example, the landlord may offer $22/RSF for tenant improvements. If the space is 3,500 sq. ft., the landlord agrees to pay up to $77,000 for the project. To determine if a TI allowance is sufficient, the tenant should work with one or two contractors to get a preliminary bid for the desired renovations.
The terms tenant build-out, tenant improvement, and leasehold improvements are often used interchangeably. There is no substantial difference between the definitions of a tenant build-out and a tenant improvement, but the terms are sometimes used differently in the industry.
Commercial real estate agents, brokers, and property management companies generally refer to a unit’s renovation work before occupancy as tenant improvement. However, project managers, general contractors, and landlords more often refer to the same work as a tenant build-out, while accountants and tax professionals may prefer the term leasehold improvement.
The time to establish and define a tenant improvement allowance is during the lease negotiation period. While your ideal commercial unit may be full of expensive light fixtures and natural hardwood floors, it is not likely the landlord will agree to extravagant wish lists. But don’t be discouraged if they reject your proposal. Instead, use that as an opportunity to get creative and craft a more acceptable offer.
Before starting negotiations regarding tenant improvements, prepare a list of needs vs. wants. When negotiating TIA, the objective is to secure enough of an allowance to cover all construction costs required to get the unit “move-in ready.” It is a good idea for tenants to work with a commercial real estate agent, or broker, that can help facilitate productive negotiations with the landlord.
Tenant improvement allowances empower tenants to create the perfect unit in an already great location. Knowledge is power when it comes to understanding the relationship between tenant and landlord responsibilities. Keeping track of all of the details of a new lease can be overwhelming, but that’s where Leasecake can help.
Leasecake enables commercial tenants, brokers, and franchisors to keep track of their leases, documents, and tasks in one simple app. You can schedule a demo here to learn more from one of our team members.
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