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When it comes to negotiating a tenant improvement allowance, there are common phrases you will hear from commercial listings agents while space tours:
"We can turnkey the space for you."
"The landlord is willing to put in the work."
"The landlord will provide the cash and you can spend the money."
Most spaces need renovation, if not a substantial facelift. Most landlords have deep enough pockets to play banker - afterall, if they throw money at making space more beautiful they end up leasing their space.
1) You should always ask for a cash allowance first, and then settle for a tenant improvement allowance second.
They are the same thing except that a cash allowance is a check with no questions asked. You can take the next flight to Vegas with it if you wish. A tenant improvement allowance (also known as a leasehold improvement allowance) means you actually have to improve the space. Also, you have to come up with your own money to first pay for the improvements, and then you are reimbursed. It should really be called a tenant improvement reimbursement.
2) Know that you are being charged 10%.
There is no such thing as a free lunch. While the landlord is reimbursing you for the cost of construction, they are also charging you 10% on the money they are "lending" you. It is because they have an "opportunity cost". If they lend you money to build your space, that is money they do not have to buy the next building.
So if the landlord provides the allowance and does not move the $20 net rental rate, the effective net rent is $12.50 ($20.00 - $7.50) - not a good deal for the landlord compared to you leasing it at $18 and doing your own work.
Therefore the landlord would counter with absorbing the construction amount and the net rent goes up to $25.50 ($18 as the "finish line" as-is rental rate, plus the amortization of $7.50 per square foot per year).
If you can get access to cash at less than 10% (most of us can do much better than that!), then you would be further ahead to spend your own money and take the $18 as-is, final net rent.
The downside is that you have $150,000 less available to you to operate your business.
3) Generally the landlord offers half of what is actually required.
As per the example above, a "turnkey" allowance is usually not turnkey at all. In most cases it is only 50% of what is actually required. This allows the landlord to advertise a more digestible net rental rate and you get to the next step of commitment.
Once you find out the landlord allowance will not cover your entire build out cost you are typically emotionally connected to the space and find the extra funds on your end to cover the total cost.
4) Always get permits.
We just saw a case in which a law firm did their own work, and thought they could demolish a demising wall without a permit. The demolition and construction went smoothly, they successfully expanded into the adjacent unit and everything went well.
The problem came when they applied for their reimbursement and the landlord required a building permit. Since they did not have a permit, the landlord would not release the leasehold improvement allowance.
5) Ask for Progress Payments.
Most lease clauses state that a tenant must complete their entire project before submitting receipts for reimbursement. This could create a 90-120 day cash bottleneck.
Suggest asking for 2-3 progress payments so that on a three-month construction project that is expensive, you are reimbursed three separate times, not just one lump sum at the end of the project.
6) Ensure the amount is PLUS taxes.
This minor oversight will cost you an amount equal to the state or provincial tax. Here is a recent example from Toronto - in which the amount did not mention taxes. The Province of Ontario has 13% tax.
One tenant at about 10,000 square feet achieved an allowance of $339,000 ($30 per square foot, plus 13% tax), and another tenant received $300,000 (10,000 square feet x $30 per square foot, no mention of tax).
7) Apply the balance to free rent.
A typical landlord will reimburse for receipts rendered and they will "keep the change". A proper leasehold improvement allowance will state that the unused portion shall be applied to rent as it falls due under the lease.
I have seen a case in which a renewing tenant was allowed to apply that unused portion to rent in the renewal term. Not all landlords would allow for this, and it was only discovered by the tenant's new broker - the tenant has completely forgotten about the allowance and how much was spent during the last construction period. This is especially important if you are providing a personal guarantee as part of the lease.
Here is an example of a tenant-friendly Tenant Improvement clause (from a recent lease from California):
The Landlord hereby agrees to pay to the Tenant an allowance (the "Tenant Improvement Allowance") of thirty dollars ($30.00) per square foot of Rentable Area of the Premises, plus applicable taxes. The Landlord shall pay the Tenant Improvement Allowance to the Tenant in installments as costs are incurred by the Tenant as established by invoices delivered to the Landlord for work done in the Premises. Any unused portion of the Tenant Improvement allowance shall be paid as a cash allowance (the "Cash Allowance") to the Tenant on the Commencement Date. Any additional costs to improve the Premises shall be at the sole cost and expense of the Tenant (other than costs outlined in Schedule "B"- "Landlord's Work" attached here to).
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