When negotiating a commercial lease you typically ask to receive a tenant improvement allowance to cover tenant build out costs such as new flooring, new walls and paint, demo, etc. Before signing the commercial lease contract it’s always a good idea to get at least 2-3 preliminary construction bids to make sure the total cost does not exceed your negotiated TI allowance.
However tenant finish-out projects don’t always meet their budget for a variety of reasons. For example if the tenant makes changes to the scope of work or the contractor discovered a large ticket item that was not known during the preliminary construction bid. Either way there will be times when the total tenant build-out costs exceed the negotiated tenant improvement allowance.
So what do you?
Well you have a few of options which need to be negotiated before the commercial lease is signed and executed.
- The first option is for your company to come out of pocket and pay for the build-out costs that exceed the tenant improvement allowance up front.
- The 2nd option is for you to get a loan like an SBA loan.
- The other option is to negotiate an additional allowance (aka amortized TI) that covers the overage amount and amortize it into the lease. We will discuss in more detail below.
What Does Amortization Mean?
In business amortization means to spread payments over multiple periods. For example the amortization of a loan that includes principal and interest that is determined by an amortization schedule.
Amortized Tenant Improvements (TI) Allowance
This is essentially a loan from the landlord for the additional allowance that the tenant has to pay back over the life of their term. The landlord will typically give this money upfront to pay for the improvements. When it comes to amortizing tenant improvements it basically means you don’t have to pay back the money all at once. The money is being added to the total rent due at an interest rate the landlord charges and divided by the number of months in the lease term.
When Do You Negotiate the Amortized Tenant Allowance?
The additional allowance is typically negotiated during the initial lease term negotiations on the term sheet or proposal. This is done fairly often as it’s nice to have the ability to tap into it rather than having to go to the bank for a loan.
Interest Rate for Amortized TI
The interest rate will vary from landlord to landlord and dependent on the market however in most cases it will range from 7% to 9% per annum
How To Calculate Amortized Tenant Improvements
Suppose your leasing 3,000 sf of office space for 5 years and the landlord has agreed to give another $30 sf above and beyond the initial tenant allowance at 7.5%
- Using a Google sheet or financial calculator enter the amount of the loan
- Enter the annual interest rate
- Enter the term of the loan
- Enter payments per year
- Amount of loan = $90,000 ($30 x 3,000 sf)
- Annual Interest Rate = 7.5%
- Term of loan = 60 months (5 year lease)
- Payments per year = Same as when rent payments are due so = 12
When you enter the above information to a Google Sheet you get the Tenant Improvement Amortization Schedule.
As you can see $1,803.42 is the additional monthly payment that will be added to your total monthly rent.
Benefits of Amortizing Additional Tenant Improvement Allowance
The main benefit is it gives the tenant some backup funding in the event the build-out costs exceed the tenant improvement allowance. You may not have the cash on hand to cover it so having this pre-negotiated will eliminate any worry. Many startups or new businesses are typically in this situation. If costs go over you can avoid having project delays and be able to finish out the space the way you want, rather than having to scale back on the scope of work.
Example of Amortized TI Allowance
If the cost of the Landlord’s Work exceeds the Construction Allowance, then Tenant may, prior to the conclusion of the Landlord’s Work, request that Landlord increase the Construction Allowance by the amount of the excess, up to a maximum of $51,420.00 (the actual amount of the increase being the “Additional Allowance”). If Tenant timely requests the increase in the Construction Allowance, then Landlord shall increase the Construction Allowance by the amount of the Additional Allowance. Landlord shall prepare, and Landlord and Tenant shall promptly execute and deliver, an amendment to this Lease increasing the Base Rent by the amount needed to amortize the Additional Allowance over the Lease Term at 8% per annum, with the increased payments commencing with the first Base Rent payment due under this Lease.