A tenant improvement allowance is a clause in a commercial lease, in which the landlord agrees to compensate the tenant – or directly pay for – all or part of the cost to improve or build out the tenant’s space.
Other terms for a tenant improvement allowance are TIs, TAs, TIA, TI allowance, or leasehold improvement allowance.
How Is A Tenant Improvement Allowance Calculated?
Tenant improvement allowances are usually calculated on a per-square-foot basis. For example, if a tenant has a 10,000 square foot suite and the landlord offers TIs in the amount of $20 per square foot, the tenant’s improvement allowance would be: 10,000 SF x $20 = $200,000.
At first glance $200,000 might seem like a lot of money. But if a tenant is moving into a raw space or plain vanilla shell, the cost of TIs can add up quickly.
What Do TIs Cover?
Landlords look at TIs as leasehold improvements that will stay with the space when the tenant leaves. Tenant improvements are broken down into hard and soft costs.
Hard costs in tenant improvements include items such as:
- Heating and air conditioning systems, electrical, and plumbing,
- Interior framing and walls, doors and windows,
- Lighting, drop ceilings, painting and flooring.
Soft costs in tenant improvements can include:
- Permitting and planning fees,
- Design, architect, and attorney fees,
- Construction management fees.
What Do TIs Not Cover?
When landlords give tenant improvement allowances, their goal is to improve the space for the current tenant and make the space more valuable for the next tenant to occupy. This will allow the landlord to justify a higher rent the second time around, since the space will be move-in ready.
That’s why landlords would generally not pay for TIs that aren’t useful for future tenants. Tenant improvement allowances usually don’t cover:
- Tenant moving expenses,
- Phone line installation,
- Data cabling,
- Furniture, fixtures and equipment,
- Lighting fixtures and window coverings.
Are There Hidden Costs in Tenant Improvement Allowances?
Most tenant improvement clauses in commercial leases are straightforward. They state the dollar amount of the TIs, and how the TIs are paid. But the total tenant improvement allowance can also include items that eat away at how much TI money a tenant actually has available for physical improvements.
Some hidden costs in tenant improvement allowances that tenants should look for include:
- Landlord supervision fees and overhead fees – These often run 3% to 5% of the total TI amount.
- Sales tax – Tenant improvement allowances that include payment of sales tax are effectively reduced by the amount of tax that is paid, meaning less money spent for actual TIs.
- Unionized labor use – Unless the landlord is required to do so, using non-unionized labor can significantly reduce the construction budget for TIs.
- Use of landlord’s contractors – Some landlords have an approved list of contractors for TI work. While this isn’t necessarily a bad thing, it can also prevent tenants from choosing less expensive tradespeople to hire if the landlord’s contractors are too expensive.
- Makegood fees – These require the tenant to pay the landlord for restoring the space back to its original condition, even if this isn’t done right away.
How Do Landlords Pay for Tenant Improvements?
Tenant improvement allowances are usually structured in one of two ways:
1) Turn-Key Build Out – Under this structure the landlord pays for the cost of the tenant build out based on an agreed-to space plan and delivers the space to the tenant in ‘turn-key’ condition.
This can be a good option for tenants who can’t or won’t get involved in building out their suite. Potential problems for tenants using the turn-key build out approach for their TIs include the landlord overestimating costs and cutting corners on quality. When this happens, a TI allowance expense ends up turning into a small profit center for the landlord.
2) Fixed Dollar Amount – Under this TI structure the landlord reimburses the tenant a flat dollar amount to be used for TIs, including both hard and soft costs.
The fixed dollar option gives the tenant control over the tenant improvements and avoids the potential problems with the landlord offering a turn-key build out. Drawbacks for tenants receiving a fixed dollar amount for TIs include paying out of pocket for TIs until being reimbursed and having to spend valuable time overseeing the TI project.
How Can Tenants Get the Most from Their TIs?
Tenants negotiating a lease with a tenant improvement allowance should try to get as much as they can from the landlord, maintain as much control over the build out process as possible, and be allowed a flexible use for their TI money:
- Ask the landlord to waive or reduce their project management fees, and allow the tenant to hire their own project manager or general contractor.
- Receive landlord approval to use the TIs for a wide range of expenses – such as phone and data cabling, and tenant time spent on project management tasks – especially if the landlord requires that any unused tenant improvement allowance be returned.
- Apply any unused TI dollars toward the monthly rent or to hold in reserve for any future additional improvements.