The cost of doing a tenant improvement build out is usually the second most expensive part of your lease after the actual rent. It isn't uncommon for tenant improvement allowances to be equal to six months' or a year's worth of rent -- or more -- and for your out of pocket expenses to be just that high, or higher. However, TIs aren't all created alike, and one dollar in one building can mean something different from another dollar in another building. Here are three strategies to keep in mind:
Tenant Improvement Allowances Aren't Free
Landlords work backwards from a desired return. The savviest of them are concerned with the bottom line, and realize that there are many ways to get to the bottom line. So, if they charge you $50 a foot in rent for five years and give you an $40 tenant improvement allowance, they know that they will get $210 a foot over that period of time. On the other hand, if they give you a $60 allowance, they will only get $190 from you. Most landlords will want to maximize their income so, all things being equal, every dollar in TIs you get usually gets canceled out by a dollar in extra rental expense or in reduced free rent concessions. In other words, TIs aren't free money, so it's wise to pay attention to what you're giving up to get them.
TI+Shell < TI+Existing
The value of your allowance depends on the shape of the space that you are building out. If you lease brand new space in shell condition, a good chunk of your build out money will go on basics like ceiling grids, lighting, HVAC ducts and, in some building, sprinklers. On the other hand, if the space you're leasing is minimally built out, you can probably reuse much of what is already there. This lets you use your TI dollars more efficiently.
If you're taking a space that is elaborately built out and you need to completely demolish it to suit your needs, you could end up spending more than the cost of building out a new shell. In this instance, try to stretch your tenant improvement allowance by reusing as many components as you can.
TIs and Your Taxes
There is one argument to putting as much money into rent and as little money into TIs as possible, and it's that you could pay less tax. Rent payments for your business are almost always 100% tax deductible as expenses. Leasehold improvements, on the other hand, need to be depreciated over their useful lives. With the IRS eliminating bonus and accelerated depreciation for many tenant improvement projects, you could end up saving money by paying higher rent and having your landlord pay more of your TIs out of their pocket. That way, you get the rent write off, and the landlord has to worry about depreciating the work. As with all tax considerations, it's always best to have your company's tax strategy team look into the specific implications of any real estate decisions that you make.
Here are some of our other Tenant Improvement articles:
Tenant Improvement Options to Keep in Mind
Basic Tenant Improvements for Commercial Real Estate
Understanding Tenant Improvement Negotiations