What is a Tenant Improvement Allowance & How Do They Work?

tenant improvement allowance commercial spaceWhen leasing commercial real estate properties such as office space, retail space, or warehouse space, landlords will typically offer incentives to get tenants to lease space in their building. One of those incentives is offering a tenant improvement allowance (aka TI Allowance or TIA) to build out the space custom to your needs.

The tenant improvement allowance is the amount of money that landlords are willing to spend or give to a tenant to renovate an office space in the landlords office building. It's typically offered as a total dollar amount or a dollar per square foot and negotiated up front.

The goal of the tenant should be to negotiate enough tenant improvement allowance to cover most (if not all) of the total construction costs.

For example say you like a space, however it would be even more perfect if you could have 2 more offices and a break area with plumbing.  During the negotiation process you would want to ask for an allowance (MONEY) to build out the space.  The amount is typically negotiated and contingent on your credit, length of lease term. rental rate, market you are in, etc…

How Do You Get It?

It's handled differently depending on the type and size of commercial space you're renting.

Landlord Controlled

At lease signing you have to write a check for any construction costs that exceed what the TIA will cover. Then the landlord will pay the contractors and all other vendors directly for all construction costs.

In most cases with smaller office space (less than 10,000 sf) if the landlord has a construction manager they will want to hire the contractors and oversee the process. This is because they know the building well, have experience with office space build-outs, and have relationships with a lot of different contractors which they can leverage to keep costs to a minimum. When a landlord manages the construction process it's known as a “Turnkey Build-out”.

Having the landlord manage this saves you time however their interests may not line up with yours. They may not seek as many competitive bids or have any incentive to cut costs, and if you make changes after the architectural plans have been approved you will be charged change order fees.  Also, if the construction costs end up being less than the TIA you will not receive the difference. For example if the TIA was $25 sf and the construction costs ended up being $20 sf you will lose the $5 sf.

If the landlord insists on managing the construction process then make sure to request that you have the ability to be a part of the general contractor approval process and that you are given a detailed work letter that outlines the construction process from beginning to end.

Tenant Controlled

The time frame of payment of the TIA is determined during lease contract negotiations. It will either be paid out after the construction has been completed and landlord receives all the receipts, OR be paid in cash at lease signing. You could also negotiate to have it paid a progress payments as work is completed.

For larger spaces you or a project manager you hire would want to manage the construction process. This will give you more control over the costs, timing, and details of the project. In addition you have the power to select the contractor that you want.

What is the Average Tenant Improvement Allowance?

The tenant improvement allowance you receive will depend on a number of factors such as the market, lease term, your credit, type of space, etc. In general if the space is brand new (aka in shell condition) Landlords might offer $25 to $40 sf. If the space is 2nd generation (has been leased occupied before) landlords may offer $20 or less.

At the end of the day it's important for the tenant to have a general idea of how much the construction will cost. During the negotiating process it would be a good idea to get at least 1 or 2 preliminary construction bids. You don't want to accept a tenant improvement allowance of $15 only to find out that the total costs will be $25 sf.

If you are not able to negotiate enough tenant improvement allowance to cover the total costs then you could ask for additional tenant improvement allowance to be amortized.

How Do you Calculate the TI Allowance?

The tenant improvement allowance is typically given based on the rental square feet (RSF) of the commercial space. To calculate the Tenant improvement allowance simply multiply the RSF by the TI allowance you have negotiated.

For example if the square footage is 5,000 RSF and the tenant improvement allowance is $20 RSF. 5,000 x $20 = $100,000

If you need help we created a free tenant improvement calculator.

What Does it Cover?

The tenant improvement allowance typically covers architectural, engineering and space planning fees as well as the total hard construction costs. In addition, if negotiated such allowance may be used at Tenant’s option for the cost of consultants, legal fees,
moving expenses, equipment, fixtures, furniture and/or signage.

Tenant Improvement Allowance Must Be Negotiated

Again the tenant improvement allowance is a negotiated amount that the landlord will spend to customize the space to your particular needs and is typically quoted in dollars per square feet.  They won't always agree to pay for 100% of your ideal layout….especially if you are asking for hardwood floors, granite countertops, and other above standard finishes. Again landlords won't just give you a tenant improvement allowance. You must know the market and negotiate well.

When evaluating spaces make sure to take note of your needs such as the ideal # of offices, break area, conference rooms, etc.  If you need a more customized layout make sure you ask for it before signing a commercial lease.  You want to compare how much allowance each landlord is willing to give.  Ideally you want them to pay for 100% of your build-out costs, however it all depends on your credit, length of lease term, the rental rate, and on whether it's a tenant or landlord market.

Who Gets To Keep the Improvements?

The landlord is giving you a tenant allowance in return for your tenancy, and you may end up spending additional money out of your own pocket above and beyond the TIA however all the leasehold improvements will convey with the landlord. Tenant improvements-allowance.

Example of TIA in Commercial Lease Agreement

Construction Allowance.

Provided Tenant is not in default on the lease contract, Landlord agrees to give up to $300,680.00 (the “Construction Allowance”) to the cost of Landlord’s Work. Any costs of finishing Landlord’s Work above the Construction Allowance shall be Excess Costs (as defined below). Tenant shall pay Landlord a construction management fee equal to 4% of the cost of Landlord's Work to compensate for its construction management services in connection with Landlord's Work. Landlord shall deduct such fee from the Construction Allowance. The Construction Allowance is available for Tenant’s use from the date of this Lease through the last day of the twelfth (12th) full calendar month following the Commencement Date, after which Tenants right to same will expire and be of no further force and effect.

1.3 Additional Allowance. If the total construction costs exceed the Construction Allowance, Tenant may, before Landlord’s Work has been completed, ask that the Landlord increase the Construction Allowance by the amount of the excess, up to $60,420.00 (the actual amount of the increase being the “Additional Allowance”). If Tenant asks for the increase in the Construction Allowance, then Landlord shall raise the Construction Allowance by the amount of the Additional Allowance. Landlord shall prepare, and Landlord and Tenant shall promptly execute an amendment to the Lease increasing the Base Rent by the amount needed to amortize the Additional Allowance over the Lease Term at 9% per annum, with the increased payments starting with the first Base Rent payment due under this Lease.

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