Negotiating the Tenant Improvement Allowance

by CoyDavidson on November 14, 2010

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Get as much as you can, and maintain control of the build-out process

A key component of any lease negotiation is the tenant improvement allowance provided by the landlord to build-out or retrofit an office space for the tenant’s specific use. The amount of the tenant improvement allowance, as well as the length of the lease term have a significant impact on the negotiated rental rate.

In addition to negotiating a favorable amount for tenant improvements provided by the Landlord, the ability to maintain control of the process is also important.

Tenant Improvement allowances provided by the building owner to build-out or retrofit office space are typically structured in one of two ways:

  1. Turn Key Build-out: in this structure the Landlord covers all of the cost of the tenant build-out as part of the agreed upon rent and space plan generally outlining the scope of construction.
  2. Stated Dollar Amount: in this structure the Landlord provides a stated dollar amount for the tenant to use toward building out the space, often to include architectural and engineering fees.

When negotiating a lease, tenants would prefer not to come out of pocket for expenses related to building out the space. Many tenant rep brokers will often state their client wants a “turn-key” buildout, but what they technically should strive for is to eliminate or minimize “out of pocket” costs for the tenant, as well as maximize the value of the improvement allowance, based on the rental rate that is negotiated.

The Problem with the Turn-Key Approach

The inherent issue with the turn-key build-out approach is that the Landlord is going to incorporate a significant amount of contingency cost into the construction cost estimates to prevent actual costs from exceeding the estimate. This could be a contingency as much as 25-30 percent, in effect creating the potential for another profit center for the Landlord, if they efficiently manage the build-out costs. In some cases “efficiently manage” could be construed as “cut corners”.

For example, if the Landlord estimates the cost of the build-out at $35.00 per square foot, and that is the allowance the negotiated rental rate is based upon, and ultimately the Landlord is able to build-out the space for $29.00 per square foot, then the tenant has in effect given up $6.00 per square foot that could have gone towards improvements to their premises.

Another issue with the turn-key approach is that the tenant is relinquishing control of the tenant improvement dollars being spent on their space. Unless the tenant negotiates an extensively detailed work letter based on a detailed set of full construction plans, it is not uncommon to have surprises in the build-out that do not favor the tenant.

office buildout

Maintaining Control of the Construction Process

In most cases, I prefer negotiating a state dollar amount for the tenant improvement allowance and maintaining as much control as possible over the build-out process for the tenant. In addition, I request that the Landlord either waive or reduce their construction management fee, and allow the tenant to retain their own project manager to oversee the design and construction process.

The objective is to shift control of the build-out from the Landlord to the Tenant which provides the ability to:

  • Maintain quality control of the process and to insure the construction is completed on time to prevent any holdover rent fees in the case of relocation
  • “Value engineer” as well as let the tenant reap the benefit of competitively bidding the construction contract to insure you get the most value out of your tenant improvement allowance.

If possible, it is also prudent to negotiate the right to amortize additional tenant improvement dollars into the rent should you decide to add additional improvements, upgrades or incur unexpected cost over-runs before you space is completed. You may elect to just to pay any costs over the allowance yourself, but its its nice to have that option.

In cases, where the scope of work only involves new carpet, paint and moving a wall or two, having more control of the process is not as critical. However, in any significant interior construction job, I highly recommend retaining your own project manager, who will typically capture savings that benefit the tenant rather than the landlord that far exceed the fee charged by the project manager.

Choosing the stated improvement allowance approach requires more up-front work by your real estate team to insure the proper allowance is negotiated, but maintaining control of the construction process allows the tenant to realize the benefits of potential cost savings and maximize the value of their improvement allowance.

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  • http://officesearchtoronto.com/ Chris Fyvie

    Typically, I also add the tenant will be remunerated with free rent should they not use the entire construction allowance.  It’s usually easier than asking the landlord to reduce the already agreed to higher rental rates.

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  • Jessicasewell3

    wonderful tips!

  • Jcp1160404

    Novice real estate guy here…I assume a landlord packs the quoted rent with TI money. True? Is there a “rule of thumb” as to a percentage a landlord packs the rent? If the quoted rent is $20/SF, is $5 for TI?

  • http://www.coydavidson.com/ CoyDavidson

    Typically the quoted rent includes some tenant improvement allowance. The % as a component of rent is subject to market conditions and other variable such as the term of the lease and the Landlords investment return requirements. A tenant improvement allowance is similar to a loan from the landlord, the longer this loan can be amortized the more the landlord is willing to provide more up-front cash. So in theory the longer the lease the more tenant improvement that can be negotiated. You might take a look at this post http://bit.ly/I2XfTP

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  • Turnkey rentals

    thanks for posting such a nice article. people
    will be benefited for that. i am also helpfull for that. many important
    information are include in here.

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  • Tarek

    I am a commercial Landlord and have 25 years of Tenant Improvement contractor experience. My experience is that most tenant just do not have the experience to deal with all the logistics involved with in the design and construction process. Many would be better off leaving it to the LL to handle. The LL is most familiar with the building and usually has a list of trades familiar with the building and local governmental idiosyncrasies. Coupled with volume discounts the LL is likely to get, it is doubtful, that the tenant will achieve any savings. Tenants are better off focusing on their business and getting opened.

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  • Gail Harris

    I just rented a commercial building to open a tea lounge is my landlord responsible for the build out because it was not included in my lease

  • http://www.coydavidson.com/ Coy Davidson

    The Landlord would only be responsible for your build-out if it WAS written into the lease. While it is common for a Landlord to provide some buildout funds in a commercial lease, it is a negotiable business term that must be negotiated prior to executing the lease. In some cases, more often in retail, the tenant is responsible for a significant portion of the renovation costs.

  • Possible tenant

    Good article. I just went through this process. Basically, I’m interested in renting a raw space for a future wine/beer bar that has been vacant for a long time. In the original LOI, the LL offered to pay $78K for the TIA, but I had a contractor estimate what it would take to build out this space (based on a basic floor plan with materials to be used). It was a lot more and I did not want to put all my money into the business up front – especially since I felt this was improving his space. So, I estimated what the most I would put in up front would be and as the estimates kept piling up (architectural fees, including for Engineering and Plumbing), I essentially added to his original TIA and then countered with a much, much higher figure that was based on real numbers. He accepted it! Now, he does want a longer lease, which I will agree to, but I bargained for 5 months abatement, and the rest of the year half-rent and the final rent is lower than what he originally wanted. Lawyers looking over the lease now, so we shall see! My main point is, do your due diligence and homework beforehand. Don’t be desperate and be prepared to walk away. Unless there is lots of competition for the space, you’ll find the LL will be more amenable.

  • Gail Harris

    Thanks Coy for the information… knowledge is power I missed out on this opportunity by not knowing.

  • Kelly

    Is there a rule of thumb for prorating expenses for improvements (e.g. tile/carpet flooring) for an existing tenant who has been in their space for many years? I’ve inherited the property mgmt responsibility for my parent’s commercial property, and it needs some updating. (e.g. A 50/50 split for these improvements between the landlord and tenant?)

  • http://www.coydavidson.com/ Coy Davidson

    There is no rule of thumb, what you are able to negotiate as a tenant or landlord is based on local market conditions and supply and demand. In a tighter market a landlord will typically ofter less of an improvement allowance.

  • Carlos

    Excellent, thank you!! We are in the process now of looking at a raw space. They said they would give us a 30 sq ft credit. So I am assuming this would be rolled into the rent to pay back or is this “free money”?

  • http://www.coydavidson.com/ Coy Davidson

    Carlos it is never free money. The $30.00 PSF allowance is part of their proforma. As reference you might look at this article: http://bit.ly/1wN1IEa

  • Jose G.

    Hi, possible tenant, and everyone else. I really need your guidance. I’m looking into establishing a restaurant/bar. The commercial property has a second floor, great location, and its an up coming location. The market has been in the market for 1 year. Every store has a tenant except for this one. The owner wants me to bare the cost of all construction. The ceilings are too low, I need to destroy half of the second floor to get higher celings. There is no gas, and there is a 100w eletricity, and no water piping. There are two bathrooms, that is the only plus. Anyways, to make story short. She is charging me $4,000 for a 2500 foot place. She is giving me 4 months free, and for me to bare the cost of installing gas, create ventilation for kitchen, and upgrade electricity from 100w to higher, and any remodeling such as knocking second floor will be up to my expense.

    My question: Is this woman CRAZY? I really want this place, but I will spend a lot of money. Should I ask her for one year free? Is the above scenario common? Any advice is really appreciate it.

    First business, and first restaurant.

  • http://www.coydavidson.com/ Coy Davidson

    Your ability to negotiate a tenant improvement allowance or free rent in lieu of construction dollars is dependent on market conditions for this particular property and your negotiation leverage. It is hard to say whether her terms are market without knowing the market conditions for this particular property.

  • Christina

    This article was so helpful, thank you! My husband and I are currently negotiating for a 20,000 sq.ft warehouse space to begin our Gymnastics Center. Our contractor said it would cost $80,000 to build lobby and a platform for pits and trampolines. Owner offering $118,000 in TI but this make the rent a little bit too high. We want to try to pay for all improvements on our own using previous business buyout moneys, a home equity and our 401K. If we can do this, is it wise? We will be doing a 10 year lease but at least we know where our money is going and not charged 10% interest in the TI. This will also give us months free rent and a lower lease. Does this make sense? Thank you in advance for your thoughts!!

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