Image credits: Cushman & Wakefield
Commercial real estate properties almost always require some level of improvements or buildouts to become inhabitable for a specific tenant. The costs for retrofitting a commercial building to suit your needs as a tenant will vary according to the type of changes you want, which is why splitting the financial contribution with the building owner can help you a lot. This is achieved through a tenant improvement allowance (TIA) offered by the owner to support either a part or the whole of the project, creating a huge incentive for you to lease the space. Such an allowance makes up a major project fund for your planned customizations within the building, and by calculating tenant improvement allowances, you can adjust your final budget to give your buildout a good head start. Here is how you can calculate the allowance and negotiate the amount more impactfully.
Calculating Tenant Improvement Allowance
What It Means
A tenant improvement allowance is mutually agreed upon between a tenant and a building owner before signing the lease, so this pre-negotiated amount is already decided beforehand. It is stated as a per-square-foot cost and can cover either a part of the total buildout costs or the whole amount. Once you select the space you want to lease, the next step is to confirm what kind of changes – or tenant improvements – you wish to add to the building in order to make it better equipped for your business.
For example, you might decide that the existing space requires 2 extra private offices and a break room, so your tenant improvement project will include everything that makes this possible. The total costs can be difficult for you to tackle all by yourself, which is why negotiating a generous allowance will help you fuel your project more efficiently – and move in that much quicker.
What It Covers
Since tenant improvements strictly refer to the permanent, code-compliant, and physical improvements made to a commercial building, a TI allowance also covers only the costs required for such alterations. These changes will be left behind in the building at the end of your lease, which means that the owner usually has the right to reuse them for the next tenants, considering the fact that the owner did pay for these improvements. TI costs are normally the hard costs for a typical buildout, so you can expect your allowance to cover the following areas based on the approvals you receive for your specific business type:
- Architectural and engineering details
- Paintwork and wallpaper
- Additional rooms and cafeterias
- Kitchen and bathroom updates
- Office workstation layouts
A tenant improvement allowance comes with a few key exceptions such as furniture, equipment, moving costs, cabling, etc., so you will not count them as a part of the given allowance. Instead, you will pay for these on your own. Additionally, it is important to clarify in the lease who pays for expenses that exceed the initial allowance in case the project incurs delays or last-minute changes. Otherwise, you will also have to pay for them from your end, and this can impact your financial standpoint as a business if you are already on a tight budget. The lease should also cover what happens to the leftover allowance so that you will know whether to return the remaining money back or use it for future renovations.
Why It Is Offered
Building owners generally decide to contribute to a tenant improvement project if they feel that the added changes will go a long way and secure consecutive leases down the road.
A tenant improvement project is planned, controlled, and driven by the tenant instead of the building owner, so the changes can be very tenant-specific. For example, office customizations for one tenant will usually only benefit other office tenants, restaurant alterations can only be reused by another restaurant or café tenant, medical buildouts can only ever work for medical tenants, and so on. Therefore, a building owner will be very careful about spending money on a project in case all the improvements need to be torn down for the next potential tenant – especially if there is a change of business type.
To ensure smooth occupancy and successful leasing, the owner might feel more motivated to fund improvements like a lobby addition or updated utilities because these changes will improve the property’s value – and all commercial tenants can benefit from them, so the risk metric is low. Higher allowances are possible for commercial buildings that are made available to you in a shell condition, as they require extensive work to come up to a basic standard. You can also secure a good allowance if your lease duration extends 5 years or more – since this promises rent assurance for the building owner. Previously finished buildings, however, might not garner that much financial support because they already come with prior improvements in place.
When It Is Paid
The building owner can choose to pay the allowance in advance when you sign the lease – in which case, you will have the funds ready to go before the work begins. The owner can also choose to reimburse you at the end of the commercial buildout once all the improvements are in place, which means that you will be expected to have some upfront cash to get the work started. To eliminate guesswork, confusion, and conflicts, it is important to clarify the time and method of allowance payment during your lease negotiations.
How It Is Calculated
Calculating tenant improvement allowances is quite straightforward. Since this is a per square foot amount, you can use the following method to work out your total allowance:
[TI allowance per square foot] x [Total rentable square feet]
Here is an example to make things simple:
- Leased space size: 10,000 square feet
- Negotiated TI allowance: $20 per square foot
- Total TI allowance: $20 x 10,000 = $200,000
Your total TI allowance is the actual cost reduction or discount you will receive for your project, which means that you will subtract this amount from your initial budget as it is now covered by the building owner. Therefore, your new budget (and your out-of-pocket expense) will be:
[Initial budget] – [Total TI allowance]
If you are lucky and a smart negotiator, you might even secure full coverage for your buildout costs, so you will not pay for the improvements at all. From the above scenario, the total TI allowance of $200,000 can be given by the owner either as upfront cash or as a reimbursement amount at the end of the project.
Commercial lease terms have a degree of fragility considering the number of legal setbacks they are prone to. For this reason, it is important to get in touch with a team of legal experts and leasing agents who can help you read between the lines and understand your part as the tenant before signing the lease. Since TI allowances form a crucial part of lease negotiations, you need someone who knows commercial real estate enough to help you get the numbers right, so always make sure to work with both legal and real estate professionals. In this way, you can focus on running your business instead of worrying about a building code violation or other red flags that will slow you down.