Tenant Allowances: Money with Strings Attached
A hair stylist is looking to open a new salon. A strip retail plaza nearby has space, but it will need to be renovated to accommodate the layout and equipment the salon needs.
Across town, a large law firm is consolidating its office spaces into one central location. A newly opened office building 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.
In both scenarios, like many others, improvements to existing commercial spaces can be very costly. So, if the would-be tenants (the stylist and the law firm) can’t pay for or obtain funds on their own, they might ask their respective building owner for financial help. When a landlord offers such upfront funding, it’s commonly called a tenant allowance. We like to call it money with strings attached.
How Tenant Allowances Work
Tenant allowances are similar to a loan that the landlord agrees to provide as part of a lease agreement. The landlord pays out those funds as work is completed on the property. The tenant repays the principal (and imputed interest) as part of rent usually over a specified amount of time that could be equal to or less than the lease term. Sounds great, right? But of course, there are stipulations. Two key strings are how the monies can be spent and when they are available.
Pitfalls to Avoid
Tenant allowance funds can be used to build out 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 ceilings and no interior partitions. The allowance is usually intended to cover the essential build-out costs (walls, ceilings, lighting, painting, etc. common to any user) along with some portion of the costs necessary to customize space for a specific use.
Tenant allowances can also be used to pay for 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 restaurant taking over another restaurant, for instance) there typically will be at least some changes needed to paint color, signage, lighting or carpeting.
In either case, 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.
Timing of funds can be another 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 has to pay the contractor with its own funds and then ask for reimbursement from the landlord. This arrangement requires both someone to manage the payments and the necessary cash to bridge the period of time between the vendor invoicing and landlord releasing the monies. Furthermore, the lease will usually state that work has to be completed and funds requested by a certain date or the allowance will no longer be provided. So, if the work doesn’t get done in time, the money disappears and the tenant must cover the renovation costs.
Another obstacle tenants sometimes face is in estimating the amount of money required to complete the improvements. The tenant might obtain a contractor’s bid for the job at $80,000 but not take into account 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 Help with Tenant Allowances
Whether you’re a landlord or tenant, allowances call for careful negotiation and administration. Some brokers understand nuances and are able to help. Otherwise, project managers like ours help folks estimate renovation budgets, negotiate appropriate arrangements, and then make sure payments to contractors are made on time either by direct request of the tenant or through funding requests on the tenant allowance. Additionally, we coordinate responsibilities and work between landlord, tenant’s contractor and other occupants.
Whether you are on the tenant or landlord side of leases and tenant 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.