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Tenant improvement allowances and what they cover

by on General

If you are searching for commercial real estate to lease for your business, you already likely know that the new space will need moderate or significant modifications to fit your company’s needs. While these construction costs can be intimidating, tenants have the option to have the landlord mitigate these expenses by doing some of the build-out or paying towards it.

A tenant improvement allowance, or TIA, is a sum of money provided by a landlord to pay all or some of a tenant’s build-out costs for a commercial space. These agreements are typically negotiated as part of the lease negotiations, greatly minimizing a tenant’s out-of-pocket expenses. Landlords who offer TIAs benefit by attracting and retaining quality tenants.

How are tenant improvement allowances calculated?

In many cases, you’ll need extensive alterations when leasing a new space for your business. Tenant improvement allowances may be lump sums, but are generally negotiated based on square footage. For instance, if the owner agrees to pay $25 per square foot and your office space is 10,000 square feet, the TIA would be $250,000.

It is essential to clarify whether the amount is based on “usable” or “rentable” square footage. Overall, the rate depends upon several factors, such as location, the space’s condition, competition in the real estate market and your credit and tenant history. Other factors include whether the landlord owns other units in the building and whether the renovations improve the property’s value.

Controlling the construction process

The tenant or landlord can manage the construction, which is also negotiated in the lease. The three typical arrangements are:

  • Tenant-controlled build-out: The tenant chooses the contractor, oversees the work, timeline and tracks the tenant improvement allowance budget.
  • Landlord-controlled build-out: The landlord manages the project, but allows the tenant some input over bids, plan approval and oversight.

A turnkey build-out may be advantageous if you don’t want or need to be involved in the construction process. However, pushing for a TIA typically means you can exercise some control over the project.

What does a tenant improvement allowance typically cover?

Some small business owners believe a TIA covers all their expenses related to the move. Landlords typically want to limit the agreement to basic construction costs. Tenants may want to include labor, architectural fees, permit fees and legal costs. Expenses typically not included are:

  • Cabling
  • Internet
  • Office furniture and décor
  • Moving expenses

All of these items must be negotiated and put into writing. Landlords may be more willing to include some of these additional expenses in return for longer-term leases.

How are tenant improvement allowances typically paid to the Tenant?

Typically, if the Tenant controls the build-out or even part of it, the TIA is paid out to the Tenant as a reimbursement based on certain stages of completion and proof that the work was completed. Sometimes the Landlord pays the Tenant for the TIA after all the work has been completed and mechanics lien waivers are received so that the Landlord is certain that contractors will not be suing the Landlord for unpaid work that was performed. Obviously it benefits the Landlord to delay payment until all work is completed and the Tenant can provide a lien waiver from all contractors and a certificate of occupancy. It benefits to the Tenant to obtain upfront monies and ongoing payments from the Landlord.

Essential considerations for negotiating TI allowances

It is advisable to consult with an experienced commercial lease attorney who can carefully evaluate all aspects of your lease agreement, including a TI allowance. A knowledgeable lawyer can identify potential legal and financial risks, including underestimating construction costs.

Getting multiple bids can help you ensure that the space meets your needs and that you’re not stuck with unexpected bills later. It’s vital to understand whether you’ll need to front any costs if the allowance isn’t paid until the project is completed. Your lawyer can also negotiate that any funds left over at the end can be rolled over into free rent or used to cover other expenses.