Downtown, a large business looks to sublet several floors of its space. Many potential occupants/sublessees are interested but will need to modify the existing walls and finishes to satisfy their unique business needs.
Mid-town, a large accounting firm is consolidating its multiple offices into one central location. A newly opened office building now has two floors available for lease. Right now, the space is a blank slate, the firm can fit out the interior to suit its staff perfectly.
And on the east side, a company is looking to create a healthier and wellness-focused workspace, requiring some changes to their interior facilities.
In all these scenarios, improvements to existing commercial spaces can cost a significant amount. If the tenants can’t pay for or obtain funds on their own, they might ask their respective property managers and building owners for financial help. When a landlord offers such upfront funding, it’s commonly called a tenant improvement (“TI”) allowance. In our view, it’s money with strings attached.
How Tenant Allowances Work
Tenant allowances function somewhat like a loan that the landlord agrees to provide as part of a lease agreement or amendment. The landlord usually pays out those funds as work is completed on the property. The tenant repays the principal (and imputed interest) as part of the monthly rent amounts. Of course, there are stipulations. Two key strings include how the monies can be used and when they are available to the tenant.
Pitfalls to Avoid
Tenant allowances can typically be used to pay for physical renovations of an existing space. When a new business takes over a space, renovations are almost always part of the move. Even if a new business replaces a similar one (a new company taking over an office space, for instance) there typically will some changes needed to paint color, signage, lighting, or carpeting.
Tenant allowance funds can also be used to build out an unfinished space (also known as space in shell condition). Spaces in shell condition typically are weathertight, with a roof and exterior walls, windows, and doors, but may only have bare concrete floors, exposed open structure, and no interior partitions. The allowance amount is usually set to cover the essential build-out costs (walls, ceilings, HVAC, lighting, etc. common to any user) along with some portion of the costs necessary to customize the finishes for a specific use.
Whether a renovation or build out, landlords require that a minimum amount of the tenant allowance be spent on “hard” improvements to the space (think further investment into the property), and limit funding of special or soft costs like design, a point-of-sale system, or furnishings, which are either unique or will not become part of the real estate (known as personal property).
Timing of funds is also one of those attached strings. Allowances may only be payable to the tenant versus directly to a contractor or vendor. In that case, the tenant pays the contractor with its own funds and then asks the landlord for reimbursement out of the allowance funds. This arrangement requires both someone to manage the payments and the necessary cash to bridge the period between the vendor invoicing and landlord releasing the monies. Furthermore, the lease will usually state that work must be completed, and funds requested by a certain date or any remaining allowance monies will be forfeited. So, if the work doesn’t get done in time, the money disappears, and the tenant must cover the balance of the renovation costs.
Another obstacle tenants sometimes face is in budgeting the total amount of money required to complete the improvements or build out. The tenant might obtain a contractor’s bid for the job at $80,000 but not consider that design, engineering and permitting fees could add another $20,000 to the project’s price tag. While not a direct string, tenant allowance funds are often not enough to cover the entire costs of the project (design, construction, furniture, equipment, move, new stationery, etc.). Tenants, especially those who are launching new businesses, typically must also seek out bank financing or pull from their own savings to make up the shortfall.
Professional Guidance with Tenant Allowances
Whether you’re a landlord or tenant, allowances call for careful negotiation and administration. Our project managers help clients better estimate renovation budgets, negotiate appropriate funding arrangements, and then make sure payments to contractors are made on time whether directly by the tenant or through funding requests on the tenant improvement allowance. Additionally, we proactively coordinate responsibilities and work between landlord, tenant’s contractor, and other vendors.
Whether you are on the tenant or landlord side of leases and tenant improvement allowances, we’d be happy to discuss how we can support you. For more information on the services we offer clients, browse some of our other articles—or give us a call at 888.357.7342.