Today we will be discussing the Tenant Improvement Allowance, often seen in leases as "Improvement and Alterations." If you've missed any of our first three, you can read them here: Subordination and Attornment, Non-Disturbance, and Rent Escalation.
New commercial space will often need to be built-out or retrofitted to suit the needs of a tenant. The funds for this build-out, ideally, come in the form of a tenant improvement (TI) allowance (also abbreviated: TIA or TA) – a negotiated amount, described as either a total amount or per square foot expense that the landlord will bear, essentially to get the tenant to absorb the landlord’s available space. Here is what you need to be careful of in negotiating and managing your allowance:
Use of TI Allowance
You want to make sure that you are able to use your allowance to cover non-construction costs (i.e. space planning and design costs, permit procurement fees, etc.). This typically isn’t too big of a hassle to negotiate, but if not done right, it can definitely hamstring you and your budget.
Secure Control of the Project
The tenant does not typically receive the money directly from the landlord. In fact, there are several ways around direct transfers of money between the landlord and tenant to avoid taxation on exchanged funds. One of these ways involves including free months in the rent schedule to offset the costs of the build-out. Regardless of how you work this out, ensuring that you are responsible for managing the renovation project as the tenant, will enable you to control what your spending and how your spending it.
Landlords often recognize the fact that any unspent dollars from an allotted tenant improvement budget comes back to them. That said, they have great incentive to cut corners and minimize costs. Further, they may look to tack on administrative and overhead charges for managing the project.
Maximizing Your Return
There is a two-pronged approach to maximizing the return on dollars spent renovating your new space. The first, of course, is spending more dollars. We say it time and again here at REoptimizer®: leverage Extreme Market Intelligence. That school of thought extends beyond creating competition for your tenancy. When negotiating your allowance, you will have more ground to stand on if you know exactly how much will need to be spent in order to meet your standards and requirements for the space. (Note: your actual allowance will also be contingent upon your credit and space requirements.)
The second and perhaps more important part to maximizing that return is spending the money you are afforded wisely. It is not always the easiest thing to take charge of all of the build-out projects. And you would be surprised to find out how building owners have a golfing buddy that just so happens to be a “preferred” (expensive) contractor that does the kind of work you need done. It is almost always the tenant’s responsibility to cover any excessive costs to the build out so make sure your landlord is doing thing the right way. That means creating a competitive bid environment for the renovation project. Also, eliminating any extra overhead and administration fees your landlord may seek to charge for managing this whole process.
Whether you realize it or not, you will be paying for these improvements. With this in mind, please do not allow yourself to be convinced that this is any type of concession. There are two ways this can work. The first being that the improvements to the property can be seen as capital improvement to the building, thus increasing the value of the property and should be paid for by the owner. The other, often argued by the landlord, is the fact that your requirements are unique in one sense or another and should be paid for by you. But don’t worry, you can rest assured they will be, most likely in the form of higher rent.
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