May 09, 2017
tenant improvement allowance
What is a Tenant Improvement Allowance?
In a commercial lease negotiation, a tenant improvement allowance (also referred to as a TA, TIA, TI allowance and leasehold improvement allowance or cash allowance) is an agreement from the landlord to compensate the tenant for all or a portion of the funds required to construct the commercial space.
It is typically expressed in a per square foot dollar amount, such as $30.00 per square foot of rentable area, and it applies to all construction related work and professional fees, but does not typically include furniture, technology, cabling and relocation costs.
TI Allowance: How it Works
Typically the tenant must spend their own money first on the build out costs and the tenant improvement allowance is provided as a re-imbursement. The payments can be progress payments as work is completed during your tenant fixturing period, or it can be in one lump sum at the end of the tenant’s construction.
This is a common misunderstanding for commercial tenants…they must pay for all the work and construction materials up front and therefore must have the cash to do so.
For example, in the case of a 2,500 square foot premises, and a $40 per square foot tenant improvement allowance, typically the tenant must cover the cost of the $100,000 in construction costs and then submit receipts to be paid after the space is fully or substantially complete.
Therefore you must have the cashflow to pay your contractor and the trades during the project before you get paid back by the landlord.
how tenant allowances work
Tenant Improvement Allowance Tutorial
We took all of the leases we have received in the past 6 months (mall leases, office leases, industrial leases, kiosk leases, restaurant leases, you name it), and we consolidated it into one video tutorial to provide you real world examples of tenant improvement allowance clauses. So if you are currently negotiating a commercial lease with a tenant improvement allowance (or if you are still at the letter of intent stage), this video will be extremely valuable for you!
Cash Allowance vs Tenant Improvement Allowance
If cash flow is an issue, we suggest converting the tenant improvement allowance to a cash allowance, paid upon a firm and binding negotiation, or upon execution of the lease. That way you will have the funds upfront and can spend the funds without having a cash flow issue.
Example of a Cash Allowance Lease Clause from a lease we just reviewed in Los Angeles, California:
The Landlord agrees to pay to the Tenant a cash allowance of thirty dollars ($30.00) per square foot of Rentable Area to the Tenant upon execution of the Lease. Said allowance shall apply towards construction of leasehold improvements and expenses related to construction, such as (but limited to) building permits, design fees, mechanical drawings, electrical drawings, professional fees and space planning fees.
What is the definition of a tenant improvement?
Before we get too far into this topic, let’s review the definition of a tenant improvement. It is any addition, alteration or improvement to a leased premises. It is mostly concerning the interior of the premises, but can include items outside of the useable area of the space as well. It is important to draw a line between the landlord’s base building systems of the property (such as HVAC units on the roof), and also tenant fixtures which go one step beyond a tenant’s typical possessions (such as furniture).
Here is an example of a restaurant lease from Canada that specifically denotes the trade fixtures:
Tenant acknowledges that the following items constitute fixtures that are required to be surrendered with the Premises pursuant to this Section 2.4 and do not constitute trade fixtures: Sinks and related plumbing; built-in stoves and stove hoods; built-in freezers and refrigerators, and all other items that are installed in or affixed to the Premises such that they cannot be removed without causing material damage to the walls or floors of the Premises
How Much Tenant Improvement Allowance Is Required?
This completely depends on the condition of the existing space, how much landlord’s work will be going into the premises, and what finishes you desire.
Local construction costs will vary, as will local professional fees. There are also more economies of scale on larger spaces.
For instance, a 10,000 square foot office with 3 offices and the rest open area will have a much lower per square foot cost than a 2,000 square foot office with 3 offices.
To provide a very general overview, here are some sample office space build outs:
Basic office build out (average tenant allowance required: $30 – $40 per square foot):
Upgraded Office Build Out (average tenant allowance required: $41 – $53 per square foot):
Premium Office Build Out (average tenant allowance required: $54+ per square foot):
Disclaimer: prices are meant to be a guideline and many factors will affect actual build out costs.
How Much Tenant Improvement Allowance Can be Negotiated?
The amount of a TI allowance really comes down to four simple factors:
Creditworthiness of the Tenant
Your ability to pay back the amount of the allowance and probability of paying the rent for the entire duration of the lease is the top factor. Your credit rating, time in business and the long-term viability of the business are all factors the landlord will consider against the risk of providing the TI allowance.
If your business does not have a great credit rating, you may have to make some compromises to get a larger tenant improvement allowance. It will likely include some kind of combination of a larger deposit, a security deposit, a letter of credit, a personal guarantee (stay away from this if you can), giving up free rent, or simply agreeing to pay more rent.
Supply and Demand in the Commercial Real Estate Market
As a general rule, landlords keep their net rental rates rather stable and then increase or decrease incentives, such as tenant improvement allowances and free rent, when the market moves from a landlord’s market to a tenant’s market and vice versa.
For example, imagine a commercial space for lease in Florida at $25 per square foot with a $10 TI allowance included within the rent may increase to a $20 allowance in a softer market, and may be reduced to nothing in a landlord’s market, all the while the $25 in rent remains the same.
Further leverage can be gained if you have the right commercial lease advice from the beginning.
The Condition the Commercial Space is In
If the space is simply in sub-standard condition and not marketable, a landlord is forced to provide an above market tenant improvement allowance to compensate, as any tenant interested in renting the space would make such a demand.
The Size of the Landlord
The larger the commercial landlord, the more likely they will provide a large TIA. This is most often the case since larger landlords have bigger pockets.
Smaller landlords typically have less money, and a lower risk tolerance so they are less likely to play the role of banker for you.
what is a leasehold improvement
lease ref helps with tenant improvement allowance
Improvement Allowance Amortization
Tenant improvement allowances are not free.
Although landlords recover their funds through the lease term, there is no guarantee that they will receive all of the funds back due to lease defaults, bad debts and bankruptcies.
So the landlord prices in an interest rate to compensate for their risk. It is normally 8% – 10%.
Although the tenant pays back the allowance during the lease term and it is just part of the rental payment, the tenant could have leased the premises for a lower rent if there was no tenant improvement allowance.
For example…a space that is available for lease at $20 per square foot with an allowance of $10 per square foot would be an equal trade off for the landlord if a tenant rented the space for $17.50 with no allowance (on a 5 year term).
That is because although the landlord receives a higher rent in the TI allowance scenario, since they had to pay out the TI allowance, it brings the net effective rent down from $20 to $17.50.
What this means is that if you have the cash to pay for the construction yourself, you will be saving the 8%-10% that the landlord will be charging.
Here is a useful tenant improvement allowance amortization video that shows the amortization factor, and the impact on signing a 5 year lease vs a 10 year with with the same TI dollars in the deal:
Should I Spend my Own Money?
This really just comes down to figuring out how you should put your money to best use.
Although the landlord charges 8%-10% interest and you could borrow money at a lower interest rate, that also cuts into your ability to use money for other purposes.
If you can instead use a line of credit and get a higher than 10% return by putting that money to use in your business through more inventory, sales reps, higher marketing spend, product development, etc. then you will be better off to put that money to use in that manner.
What the TIA Applies To
The improvement allowance will apply to leasehold improvements and the definition can normally be found in your lease. It includes (but is not limited to) flooring, walls, doors, glass sidelights, paint, specialized lighting like pot lights, specialized ceilings like drywall ceilings, glass entry doors, cabinetry and millwork.
Make sure your clause also includes other costs that are necessary for the construction process: permits, consultant fees, mechanical drawings, electrical drawings, space plan fees, interior design fees, landlord supervision fees, construction management fees, and waste disposal fees.
Unfortunately the TI allowance does not typically cover furniture, trade fixtures or equipment – so don’t be spending the money on air conditioners, appliances, computers, desks and chairs.
Do I Need a TI Request Letter?
The best way to request a TI money is to include it in your letter of intent or offer to lease.
If you trigger your option to renew, you will not receive a TI allowance as the right to extend makes the lease move forward but it will not include a leasehold allowance. So instead of formally exercising your option to renew, you will want to just work out a new deal that includes a request for a tenant improvement allowance.
Do I have to get my landlord’s approval on my improvements?
Yes. Your landlord will want to know what changes you are making, as they could affect other tenants and the next tenant that will lease your space.
Be sure that the approval process obligates the landlord to provide their permission reasonably and timely, such as this sample clause:
Review and Approval. The Space Layout Drawing (as defined in Section 2.1 below), the Store Design Drawings (as defined in Section 2.2 below) and the Construction Drawings and Specifications (as defined in Section 2.3 below) shall be prepared by Tenant’s Architect and submitted to Landlord for Landlord’s approval, which approval shall not be unreasonably withheld or unduly delayed.
What Happens to the TI if I Default?
Going out of business, failing to pay rent, or defaulting on your commercial lease does not mean that you do not owe the ti dollars back to the landlord.
Usually the amount of the tenant allowance will be stated in a personal guarantee and will be part of fulfilling the performance of the lease.
The landlord may also have an inducement recapture clause, such as this one:
Any agreement for free or abated rent or other charges, the cost of leasehold improvements for Tenant paid for or performed by Landlord, or for the giving or paying by Landlord to or for Tenant of any cash or other bonus, inducement or consideration for Tenant entering into this Lease, all of which concessions are herein referred to as “Inducement Provisions”, shall be deemed conditioned upon Tenant’s full and faithful performance of all of the terms, covenants and conditions of this Lease. Upon default of this Lease by Tenant, any such Inducement Provision shall automatically be deemed deleted from this Lease and of no further force or effect, and any rent, other charge, bonus, inducement or consideration theretofore abated, given or paid by Landlord under such an Inducement Provision shall be immediately due and payable to Tenant to Landlord, notwithstanding any subsequent cure of said default by Tenant. The acceptance by Landlord of rent or the cure of the default which initiated the operation of this paragraph shall not be deemed a waiver by Landlord of the provisions of this paragraph unless specifically so stated in writing by Landlord at the time of such acceptance.
How Does a Furniture Allowance Work?
Furniture allowances are more rare than tenant allowances, as landlords do not retain the value of the furniture as they do with physical alterations and improvements within the premises.
There are no rules or standards with furniture allowances – it would typically only be offered by a landlord if the tenant has a high credit score. Whatever you can negotiate – go for it.
How Does a Moving Allowance Work?
Moving allowances are a bit more common than furniture allowances, as every tenant will need to move into their new space, and not every tenant will need new furniture.
They are also less expensive than furniture – typically no more than $5 per square foot, so a landlord may be more inclined to offer a moving allowance as an incentive for a tenant to sign the letter of intent or lease.
How Does a Carpet Allowance Work?
This is common for new leases where the tenant’s work will just be carpet and paint, and for most spaces that will be in the ballpark of $6 per square foot for good quality carpet tiles.
It is also prevalent on commercial lease renewals in which the renewing tenant wants to freshen up the space.
In the letter of intent or on the proposal to renew the landlord may refer to the allowance as a carpet allowance to be more specific than a general tenant improvement allowance which could be spent on other improvements.
Is Paint a Leasehold Improvement?
You bet. Much like the carpet allowance, your leasehold allowance could just be a paint allowance, though it is such a small cost (typically in the range of $1 per square foot or less), that it is extremely rare to see a tenant allowance just expressed as a paint allowance.
In the case of making good on the alterations (removing the improvements and additions), it would be very rare for landlord to require you to sand and prime any any drywall for the next tenant since painting is such a straight forward leasehold improvement that it is expected the next tenant will just pick their colors and easily find a painter (plus after the leas term, most spaces require a new paint job anyway).
How Much Can a Contractor Ask for Up Front?
This is completely dependent on what can be negotiated between you and the general contractor (GC). It is not uncommon to provide a construction deposit to at least cover the first payroll period and to diligently reimburse the contractor for materials in the form of progress payments. It is not uncommon for the landlord to also require a construction deposit in the lease (for example, $5,000).
Can I install Tenant Improvements on the Roof?
Most leases allow for you to have access to the roof, but only under the landlord’s direct supervision and permission and often the landlord reserves the right for their contractors to be the ones doing the work. The primary concern is that it is an expensive and dangerous part of the building. You installing an HVAC unit without factoring in the load bearing capacity of the roof could lead to structural issues, or perhaps your installation could compromise the moisture barrier and that could lead to leaks and mold for your and other tenants.
Can I Make Structural Changes with my TI Allowance?
As with the roof example, the landlord will typically reserve the right to be in charge of structural, mechanical and base building systems of the property. That will typically mean that they reserve the right to use their own contractor for this part of your construction project. Your TI dollars still count toward these changes. Be sure that the lease obligates the landlord to be financially responsible for the maintenance of structural elements of the building during the lease term.
Construction Insurance: What is Normal?
You will need to speak with your insurance provider about your construction insurance.
Most leases require commercial general liability insurance, including products and completed operations coverage and contractual liability coverage, providing on an occurrence basis limits of not less than $2M per occurrence and $3M general aggregate, naming the landlord insured parties as an additional insureds.
what is a ti
Tenant Improvement Allowance vs Landlord Turnkey
The advantage of a tenant improvement allowance instead of having the landlord provide the suite in a “turnkey” (fully built by the landlord) condition is that you are in control of the construction project…which has three elements…money, time and accountability.
While the landlord will have experience in building out space, there is a real disadvantage with this approach…cutting corners.
Since the landlord is providing a full build out within the negotiated rent, the landlord can benefit from using the least expensive materials possible to improve profits.
For example, if the turnkey calls for the landlord to carpet the premises but no specific details are provided on the quality (for example, 32 ounce commercial grade carpet tile), then the landlord has an incentive to use the lowest quality carpet – something you may not have opted for if you were in control of the budget and installation.
The same is true for labor.
The landlord may be using the cheapest labor available and the quality of the leaseholds will reflect that.
On the other hand, if you were in charge of hiring the labor you can choose the quality of the workers.
The tenant improvement allowance approach allows you to be in control of how the budget is spent, so you can both install quality leasehold improvements where you want (for instance the reception area and the boardroom), and you can also decide where to cut corners for yourself (such as a lower quality carpet in the back-office areas).
While a landlord will have experience in building space, if you have the landlord provide a turnkey, you may not receive regular status updates on the progress of the construction timeline.
In a landlord turnkey, you are at the mercy of the landlord to get the construction done in time for the commencement date. Is the date fixed or floating? Is there a penalty for failing to deliver on time?
For example, two days of free rent for every day the landlord is delayed.
What about a flat out right to cancel the lease if the landlord is late?
Many leases have a tenant termination right if the landlord is 60 days late.
interior build out cost per square foot
If you have a TI allowance that you are spending, then you will receive regular construction updates as you are paying your project manager or construction manager.
It is also a good idea as the tenant to inspect the premises from time to time.
What happens if there are construction defects?
If you hired a construction manager or project manager, you can hold back payment until you are satisfied with their work.
Usually a landlord turnkey clause was assembled by the landlord, without any wording to hold them accountable for their work.
It is normal to hold back 10% of the budget until you do a final walk through with punch list (a list of items that still need to be finished).
Tenants normally do not involve a construction person to review their landlord turnkey clause, and even if they did, that construction professional does not have any incentive to provide any wise advice as they are not going to be involved in the project.
If you proceed with a landlord turnkey, ensure that it at least has some wording to ensure the landlord will construct the leasehold improvements in a good and workmanlike manner, in congruence with other first class properties in the neighborhood.
You may even want to put in wording that that allows you to withhold rent until the turnkey construction is to your satisfaction (though most landlords will be reluctant to agree to such wording).
Hidden Costs in a Tenant Improvement Allowance
Landlord Supervision and Overhead Fees
A TI allowance clause is usually pretty basic. It states the dollar amount and usually when and how it gets paid.
What is missing, and is typically in a separate clause in the lease, is the fee the landlord will charge to inspect the work as you construct the space.
It is normally 3% – 5% of the construction budget.
Here is an example of a lease we just reviewed for 20,000 square feet in Houston, Texas:
In addition to any other payment contained in this Article, Tenant shall pay to Landlord, on demand, a fee equal to the lesser of: 50 cents per square foot of the Square Feet in the Premises, and 10% of the cost of completing the Tenant’s Work (as evidenced by a sworn statement as to cost accompanied by receipted invoices) for coordination services provided by Landlord during Tenant’s construction of its Tenant’s Work.
In this case the landlord is willing to take the lesser of the two calculations, but it is still a $10,000 cost that could have been waived if the tenant knew to ask to have it removed.
Most landlords will agree to removing this supervision or overhead fee, so it is worth inserting this clause into your letter of intent or offer to lease:
The Landlord agrees that there shall be no overhead or supervision fees associated with inspecting the Tenant’s construction of Leasehold Improvements.
If your state or province has sales tax, is it included or excluded from the calculation. In a recent example from Toronto, Ontario, Canada, the harmonized sales tax is 13% in that Province.
The landlord worded the tenant improvement allowance to be $30 per square foot inclusive of sales tax. However, the tenant’s construction budget was close to $30 per square foot PLUS taxes.
The wording on the TI allowance needed to be changed so the tenant would actually have enough funds from the landlord to match the budget.
Before signing a lease, be sure to ask the landlord if they require unionized labor. If so, that has to be a consideration for selection of your trades and sub-trades, as unionized labor will increase your construction budget significantly.
Use of Landlord’s Contractors
Ensure that your tenant improvement allowance can be spent on contractors of your choosing.
Usually the landlord will have wording in the lease that stipulates that your contractors have to be approved by the landlord and they have to be bonded and insured.
Some leases go a step further and state that you must use contractors from the landlord’s list of approved contractors.
This can be a game changer for you, as the landlord’s list may only have very expensive contractors and you want to hire people that are less expensive.
If you have a strong relationship with your contractor, try to get your contractor on the landlord’s list of approved vendors – especially if you have some leverage (for example, you have not signed the lease yet).
Tenant Improvement Allowance Does Not Usually Equal the Construction Budget
The biggest mistakes tenants make when it comes to a tenant allowance is underestimating what the total cost will be. This is because you are guided by commercial real estate agents into this process.
Their incentive is to lease space.
So they tell you the “build out cost” in terms of just the raw construction cost. They often omit the other fees, which are usually 10-20% of the total budget, and are always a significant percentage on smaller jobs.
For example, here is a construction budget for a tenant improvement allowance of $10 per square foot on a 7,000 square foot space.
However, “consultant fees” are not included and this case it added up to another $10 per square foot (building permits, mechanical drawings, electrical drawings, interior design fees):
Keep in mind that the TI allowance is a set amount and if the construction budget increases, the allowance does not, so you end up paying the difference from your own pocket.
Although this is typically a separate clause entitled “Makegood Provision” or “Restoration Provision”, be sure to attempt to remove this clause. It is the tenant’s obligation to restore the premises to a base building condition (otherwise known as a concrete shell, or “raw” condition) at the expiry of the lease.
In some cases a landlord will charge a tenant to make good on the space (typically a $5 – $10 per square foot charge), and not complete the demolition work.
Be sure to have a clause that is entitled “No Makegood” and have it state that the Tenant shall not be required to restore or make good the Premises to base building condition, and the Landlord agrees to accept the Premises in an as-is condition at the expiration of the Lease.
Office and industrial leases more commonly have makegood provisions that get removed. Retail can be tricky as the next user may have a totally different use (it is not as easy to re-lease hair salons and dentist offices as it is office space).
You can find out more about the makegood clause here.
A Hidden Deadline for Submitting Your Request for TI Reimbursement
Many leases have a 6 or 12 month deadline, and it is a clause that is typically buried in most commercial leases. Here is an example:
If all of the conditions set forth above have not been satisfied within one hundred eighty (180) days from the Rent Commencement Date, Tenant shall be deemed to have forfeited the right to any unpaid portion of the Tenant Allowance.
In this case, if you think you have some tenant allowance left in the reserve tank and you can do work some time after the 6th month of the lease, you would be mistaken.
Likewise, if you get busy and don’t submit your approval for reimbursement, the entire leasehold allowance is at risk.
Permanent Leasehold Improvements vs Fixtures
There can be a lot of confusion on what is considered a leasehold improvement or not. Therefore you could be counting on the TI allowance being able to cover items such as a built in retail check out counter, removable shelving, audio/visual equipment for a boardroom, point of sale equipment, removable restaurant equipment such as ovens and stoves, telephone equipment, satellite dishes, specialized sprinkers, and security systems.
It is always best to assume the worst and specifically big ticket specialty items up front in the lease.
What Happens to the Unused Balance of the TI Allowance?
Since the TI allowance clause is normally drafted by the landlord, it never addresses what happens to the unused portion of the allowance. Since the landlord has agreed to pay those costs, the tenant should reap the full benefit, even if the final construction spend did not equal the allowance provided.
Therefore, tenants need to insert:
Any unused portion of the tenant improvement allowance shall be credited towards rent falling due under the lease.
Here is an example from Los Angeles, California of how we modified a tenant improvement allowance clause at the Letter of Intent (LOI) stage (it is important to do this before you get to the lease signing stage):
We recently reviewed a lease in New York in which this clause existed. The TI allowance was $12 per square foot and the tenant is 4,000 square feet. They dug up the receipts and discovered that they only spent $8 per square foot.
So there was $16,000 worth of value that was not realized, and if they had the wording above, they would have received that in free rent.
Who Owns the Leasehold Improvements?
Almost without exception, the leasehold improvements are property of the landlord upon installation.
This is because when you move out the landlord usually wants to lease the space to the next tenant with little to no renovation required. If the next tenant just needs to freshen up the space with carpet and paint, then it is a win-win for both of those parties.
There is also little value in you owning the leaseholds – you cannot take out carpet or drywall and be able to re-install it in your next space.
Accounting and Tax Treatment of a Tenant Improvement Allowance
The TIA is depreciated by the party that conducts the work.
The current tax rule is that tenant improvements are to be recorded on straight-line depreciated over 15 years.
Since rules regarding depreciation change frequently, it is best to consult with an accountant or tax professional.
Tenant Conditions of Payment (Reimbursement)
Documents the Tenant Must Submit to the Landlord:
You will need to follow the landlord’s guidelines in order to be compensated (reimbursed). The following are the generally accepted steps in typical retail, office and industrial leases:
1. A sworn construction statement signed by the tenant and General Contractor. This confirms the total cost of labor and materials and a cost breakdown by subcontractor.
2. The construction contract with all change orders (last minute changes to the original plan).
3. Certificate of substantial completion from the Architect, certifying that the work is complete or substantially complete and in compliance with the Tenant’s Plans there were approved by the landlord.
4. Drawings (sometimes they will get specific and ask for an autocad file, or the PDF file must be printable to 8.5 x 11 paper).
5. Certificate of occupancy (which is your rubber stamp, provided by the city in which the premises is).
6. Original unconditional and final lien waivers from all contractors, subcontractors and material suppliers (this allows the landlord to know that everyone has been paid and nobody will invoke a lien on the building).
7. All receipts and invoices.
Timing on Getting Paid the Tenant Improvement Allowance
Most leases provide the landlord to pay you within 30 to 60 days after the following conditions are met:
1. Execution of the lease by both the tenant and landlord (you should modify this to just you – the landlord could delay execution of the lease simply to delay payment of the leasehold allowance).
2. The commencement date (be careful – what if you negotiated a long fixturing period), or the rent commencement date (also be careful – what if you negotiated a long free rent period?). Remember that since a tenant allowance is a reimbursement, you are spending the money up front so prompt payment by the landlord will help with your cashflow.
3. Opening by the tenant of its business in the whole of the Premises.
4. Delivery of a statutory declaration of a senior officer of the tenant that the work is substantially complete, with no contractor liens.
Can I Ask for Progress Payments?
Progress payments in commercial leases are when you get the TI allowance in more than one lump sum payment at the end of the construction (for example, if you are able to submit receipts once per month during the construction period).
It is rare (typically only reserved for tenants in the 100,000 square foot range that are spending more than $50 per square foot on the construction). We certainly have not seen any tenant be succe…