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This is one of the top 10 questions we receive from small business owners - should I use my own money for leasehold improvements or take the leasehold allowance from the landlord? The best answer comes from asking another question: what do you use your money for?
If a landlord deems you to be creditworthy and a low risk of being able to pay back the leasehold improvement allowance, then they likely will be fine with providing such an allowance as part of the deal.
For example, if you want to lease 2,000 square feet and it needs to be built from scratch, it could be a $50 per square foot cost and somebody has to come up with $100,000 to buy all the materials and pay the trade workers.
If the landlord pays, there is no free lunch. He will just factor that into the deal, and most landlords charge 8% - 10% interest on that money.
So in the example above, the $100,000 is a $50 per square foot allowance. If you sign a 5 year lease, then that $100,000 will be paid back over the 5 years with interest at 8-10%.
Therefore if the net rental rate is $20 per square foot on an as-is basis, then if the landlord pays for the leaseholds, the rent will go up to about $32 per square foot (it would only jump to $27.50 if you did a 10 year term since there would be more months to amortize the loan over).
Alternatively, you can lease that space for the $20 per square foot, but you have to pay $100,000 up front for the construction.
So we back to our question...how do you use your money? Presumably in today's low interest rate environment your business can borrow funds at much less than 8-10%. The landlord is pricing risk into their offering. If you can borrow the money at 4-5% there will be quite a bit of savings.
But do you need that $100,000?
If you could take that money and invest in your business to get more than a 10% return, then you should not sweat the money you are paying to the landlord as your return is out running the amount you are paying the landlord.
Additionally, if your business is seasonal or project based, you may want to have cash reserves to weather your business cycles.
If your business is cash rich and conservative, you may not be bothered by cutting a big check upfront to pay for the leaseholds in favor of having a low rental rate for the duration of the lease.
Just keep in mind that once you construct your leaseholds they are property of the landlord, so it is not like you are paying for something you will own. Whenever you vacate the premises, all the leasehold improvements must be left in the space.
Follow up reading: ensuring you know what should be included in the landlord's base building shell.
Still a little stuck? We are the best online commercial lease review service - let us know how we can help out.