Tenant improvement is all about optimizing a leased space for commercial use. It is a very client-specific project, as commercial applications differ between businesses. A well-planned commercial buildout navigates within your budgets and timelines – and primarily meets your business needs. As a tenant, you want to move into the building with an established goal and equipped premises to reach that goal. This is why an ideal project plan will put your brand under the corporate spotlight and create lasting impressions on clients, sponsors, partners, etc. One of the first things to chase is the cost for a complete tenant improvement, and it is a crucial part of your lease. The tenant improvement (TI) allowance is the amount your landlord or landlady will cover for a part of the total buildout expenses – which accumulate per square foot of your building.
These tenant improvement costs per square foot depend on several factors like your project scope and location. A new commercial building, also known as a first-generation building, tends to be more expensive than a previously occupied space – the second-generation building. This is because you invest more in bringing a blank canvas up to a functional standard compared to repurposing an old buildout. This article walks through the various cost breakdowns according to square footage – inspiring itemized bids that you can request from your contractor.
*Update 2022* – Before you read any further about costs per foot I just wanted to acknowledge that the construction market is super volatile right now. Price escalation has hit construction costs (just like other industries) incredibly hard lately. We have seen some relief from the “highs” that we saw earlier this year but a lot of different factors such as supply chain issues, labor shortages, and rising/falling interest rates have made costs very hard to predict! If you want a real time status update on TI costs for a project please feel free to e-mail me at firstname.lastname@example.org or consult a local general contractor. What may have been accurate last year (or last month for that matter) may no longer be accurate so the best bet is to contact someone who has “real time” cost updates if you are seriously considering a tenant improvement at this time!
Tenant Improvement Costs per Square Foot
When you plan to start a new business or change locations, the costs of tenant improvement rank first in your list of priorities. This becomes even more significant when you have already negotiated a budget with the owner. The general cost of building out an existing space is governed by its condition, your commercial expectation, various permits, material qualities, etc. You can expect rough estimations such as:
- low range buildouts at $50 – $80 per square foot
- middle range buildouts at $81 – $135 per square foot
- high range buildouts at $136 – $200 per square foot
- custom finish or special use buildouts at $200+ per square foot
First-Gen and Second-Gen
The “generational gap” between buildings is another deciding factor. You will typically pay more to build out a first-generation (shell) space compared to a second-generation space. This is because upscaling from a blank shell or gray shell requires adding all the utilities and functionalities for the first time – creating the need for capital improvement projects and utilities (mechanical, plumbing, electrical) to support the space that you are looking to build out. So, you can expect an additional $10 per square foot to your original estimates when you are working on a first-gen space. If you are leasing a second-generation building, it will already be equipped with most amenities like electrical outlets, technological framework, HVAC units, etc. The previous tenant will have installed the basic additions, so you would just need to pay for accommodating your needs (assuming that you like the systems that were previously installed).
- first-gen buildouts: $70 – $200 per square foot
- second-gen buildouts: $50 – $165 per square foot
The quality of corporate interiors strongly affects the average tenant improvement costs per square foot. Custom finishes with high-end materials are naturally more expensive and aim towards quality-driven outcomes. They set the bar for executive offices in the commercial world. A basic office space would use just the standard lighting, millwork, HVAC units, and finishes (floors, ceilings, painted wall) would give you the most affordable price tag.
Upgrades to wood veneer, wall-sized glass windows, high end carpet, and extensive utilities will make a mid-range buildout. Finally, the executive office space claims the heaviest price tag, with custom artwork, granite, acoustical fabric, and premium products stealing corporate glory. This is one of the reasons why the average cost for just interior finishes has been on an upward trend over the years. Some interior improvement costs include:
- office spaces: $51 – $157 per square foot
- phone and computer cabling: $2 – $3 per square foot
- furniture: $28 – $80 per square foot
- gym: $155 – $210 per square foot
- conference rooms: $150 – $205 per square foot
- dining and kitchen: $162 – $241 per square foot
Hard Costs vs Soft Costs
These two types of improvement costs per square foot help you understand your investment better – and build the ground for impactful negotiations with the owner. Hard costs refer to the actual physical improvements made to a building. These modifications tend to remain in place even after you – the tenant – vacates the premises at the end of your lease. So, these hard costs actually benefit the owner in the long run, since you have paid for the major infrastructure and utilities to support your occupancy. Some examples are doors, windows, paintwork, millwork, HVAC units, acoustics, electrical frameworks, plumbing, and carpeting. This also means that all the material and labor cost contributions are covered as well – making hard costs devour most of the buildout pie chart.
Soft costs take up a considerably less proportion of your total improvement costs per square foot. They do not offer physical improvements to the property. Instead, these costs cover the approval, service charges, tax, and supervision needed to fuel the actual project. They may include building permits, inspection fees, and various contractual elements.
- hard costs consume around 75 – 85% of the total improvement
- soft costs consume around 8 – 12% of the total improvement
Online Tenant Improvement Cost Calculators
Various tenant improvement buildout calculators can be found online to receive averages per square foot. They usually take in details like your commercial application – for example, retail or office – and your location. They might also ask for numerical specifications that you can choose from drop-down lists. On the whole, an online tool follows the most recent calculation methods based on the latest costs in the construction market. You can receive estimates per square foot or a final cost if you have entered the total square footage. Two of such tenant improvement calculators are:
- Hurd commercial buildout cost per square foot
- Mindful Design Consulting tenant improvement calculator
Square Footage Factors
The average tenant improvement costs per square foot will always fluctuate with certain factors. They affect your total investment because your project can never begin without considering these areas. You need a good vantage point to optimize the square footage and distribute the costs efficiently. Some of the factors that drive your building’s per square foot costs – and potential – include:
- your tenant needs for commercial specialties – like restaurants and schools
- the age and condition of the building – the generational differences, renovation size, etc.
- the material and labor costs – based on regions
The TI allowance that will fund some part of your buildout is also calculated per square foot. You will negotiate these costs with the building owner as a part of your lease agreement. In a tenant improvement buildout, you stay at the frontline of the improvement process – unlike turnkey projects where the owner takes care of everything. This marks a pivotal difference in the financial leverage you can gain as a tenant planning the improvement. Since the building owner provides your TI allowance, your final improvement cost per square foot is actually the initial cost minus your TI allowance.
Negotiating Your TI Allowance
The allowance you receive from your building owner will cover most of your tenant improvement costs per square foot. This amount is entirely negotiable, and you must grab the opportunity to secure an optimistic deal. You should also bear in mind that your landlord/landlady might choose to reclaim the offered money – in the form of increased future rents, for example. So, it all boils down to a well-planned negotiation process that works for both parties. You want a fully-functional place that guarantees a successful corporate dream; the owner wants a quick and confirmed move-in. Good negotiation eliminates conflicts down the road and ensures smooth occupancy throughout your lease. Here are a few tips for making the best bargain with your building owner – and they all require you to do a bit of research.
Know Your Commercial Breakdown
Tenant improvement costs per square foot will differ based on commercial use and the level of customization needed. It helps to know your project as thoroughly as possible so that you can negotiate your allowance confidently. And the more you learn in advance, the sooner you can occupy a space that fits your standards. Different commercial spaces will require specific improvements to run those businesses. For example:
- Office tenant improvements usually focus on open and collaborative workspaces, traditional enclosed offices, conference rooms, meeting areas, reception, breakrooms, socially-distanced workstations, lounges, and various remodeled floor plans.
- Call center tenant improvements would include technology upgrades for call stations, private offices, conference rooms, reception areas, etc.
- Restaurant or café tenant improvements require extensive work on the dining areas, kitchens, prep areas, and an overall spatially optimized layout for easy foot traffic.
- Learning centers and institutes might need special improvements to include a gym and an auditorium in addition to the classrooms and offices.
- Healthcare and hospital tenant improvements are usually more expensive than others because of their medical and technological specifications. These include heavy-duty flooring and infrastructure to support the medical equipment, safety considerations for the radiology rooms, department-conscious electrical/plumbing/HVAC units, etc.
- Retail improvements often have common basics like dressing rooms, custom lighting, cashier counters, and aisled floor plans.
Your total tenant improvement costs per square foot is the combined result of all the individual changes you have planned to support your commercial operations. For each room and finished space, the required functional and cosmetic upgrades add to the final cost. So, if you have a small startup business, consider leasing mostly finished and equipped premises to save time and money.
Take Professional Advice
A smart way to understand your commercial standpoint and tenant improvement costs per square foot is to enlist the help of professionals and get a clear picture of your business goals with their relevant finances. You have to consider your lease terms carefully and make sure that you do not bite off more than you can chew. You also need to know the scope of your project before signing the lease so that you can receive enough allowance to cover the whole improvement. This includes knowing your numbers – and understanding what goes where. So, before you even start negotiating with the building owner, consult tax advisors, accountants, potential contractors, project managers, and interior designers.
Collaborating with experts will give you better insights into the project costs per square foot – and you can decide if the owner is presenting a valid allowance offer. The more awareness and fluency you demonstrate with numbers, the stronger your negotiation is going to be.
Clarify Your Expectations
Another benefit of discussing with your experts is that they can guide you about core issues like legal implications, tax responsibilities, who gets more control over the buildout, where the unused TI allowance goes, and the official rent date. Using their advice, you can negotiate your right to choose your own buildout team and have more freedom with customizations – compared to accepting whoever the owner hires.
You might want the unused allowance for covering any future upgrades, so this is something you must bring to the negotiation table. Seeking professional advice beforehand will also help you negotiate the terms of your lease better with the owner when it comes to the liability sections, for example, who bears responsibility when something goes wrong. Apart from working out a reasonable TI allowance per square foot, these expert consultations shed a lot of light on lease perspectives – so you will know exactly what to include in black and white and prevent legal setbacks down the road.
Discover Win-Win Areas
Tenant improvements usually benefit both the building owner and the tenant for many reasons. A tenant is more likely to occupy an improved and equipped commercial space that works perfectly for their business. This in turn means confirmed occupancy and incoming rents for the landlord/landlady. Also, if the owner agrees that your added changes to the space will make it more rentable for future tenants, then that is a huge tick box for a TI allowance. Anything that helps owners rent out their space consecutively will encourage them to cover your tenant improvement costs per square foot. Since the renovations you introduce will stay there after you leave, you really have no way of recovering any personal spendings on the project. For this reason, talking to an expert can help you avoid overspending on improvements – only to leave them behind after a short-term lease. You can consider bringing up such permanent improvements during your negotiations to increase your chances of a more inclusive allowance.
Another win-win situation would be an improvement that extends to other tenants in the building. Lobby renovations that benefit your business will automatically influence the other tenants as well. If your leased floor in the building has no space for employee recreation, and you plan to add a common recreation room/breakroom/gym on the ground floor – accessible to all tenants – then this is all the incentive an owner needs. In this way, what appears to be project funding to you might actually be added property value to the owner. To make the best out of the available space, take your evaluations, measurements, and initial costs per square foot to your experts. Understand the potential at hand and think outside the box with them to reach such win-win possibilities.
The Pandemic and Its TI Cost Per Square Foot Impact
The COVID-19 outbreak has influenced socially distanced workstations and downsized businesses in its wake. This did result in a staggering impact for buildout scopes, with startup firms already redefining the commercial footprint. Increased transitions to Zoom offices should have reduced the average tenant improvement costs per square foot. However, the pandemic also introduced bans on construction supply streams like manufacturing and transportation – causing a spike in material and labor charges due to resource scarcity.
Most businesses aim to keep up their brick-and-mortar presence by implementing COVID-proof precautions. This is why the construction and buildout services are expected to stay immune from the COVID impact. The increased costs per square foot during these times will, apparently, decide the future trends with companies working hard to remain open.
The Final Takeaway for Tenant Improvement Costs per Square Foot
Before you embark on the tenant improvement life cycle, make sure to get your financial bearings mapped out clearly. You will improve a raw commercial space to adapt to your business scope, so there is a lot of room for customization. The upgrades and new additions should reflect your brand identity, employee satisfaction, and reputation with clients. Most improvement projects these days focus on workspace evolution to maintain a COVID-proof environment and promote creative collaborations.
The traditional buildout portfolios are abandoned in search of new ideas, especially by startup companies who want something original. Creative spaces and quality improvements are at the nucleus of every custom buildout, as tenants do not just want a fitted-out space to move in – they look for dynamic interiors for inspired working. As a result, your project size and complexity determine your tenant improvement costs per square foot. You want to configure and personalize the space uniquely and receive accurate buildout quotes from your contractor. This brings us to bid itemization, which adds enormous relief when you are trying to narrow down the contractor pool.
Finding out exactly what you will pay for gives you a good head start in budgeting and finalizing. Most importantly, it reinforces your end of the negotiation with the owner, so you can strike up a good bargain that won’t hesitate to walk the extra mile in your buildout.
How do you calculate tenant improvements?
Tenant improvement costs per square foot can be calculated using online tools designed to provide close estimates using updated material costs, labor fees, and other prices. Online calculators like the Mindful Design Consulting tenant improvement cost calculator take in factors such as your building’s location, total square footage, finish types, number of walls, MEP and HVAC specifications, number of ADA restrooms, and so on. You can quickly receive tailored estimates for your tenant improvement costs, and the main benefit is that these tools follow the latest calculation methods and data to work out reasonable numbers – which saves you the need to use your pen and paper or complicated Excel sheets. The B7 Builders commercial buildout calculator is another good example. It uses the 2022 material and labor costs that apply to Southern California, working with details like the square footage, first or second-gen buildout, flooring types, lighting, etc. to provide both low and high-end TI cost estimates.
Calculating the tenant improvement allowance is much simpler. It is based on the rentable square feet of your leased building, so you can just multiply the rentable square footage by your negotiated TI allowance amount (as agreed on the lease). The TI allowance is usually stated as a value per square foot, so if your building owner has agreed to give you an allowance of $20 per square foot for a 5000-square-foot space, then your total project allowance is:
- $20 x 5000 square feet = $100,000
Therefore, your final tenant improvement cost (that you worked out from an online calculator) will be revised or discounted accordingly:
- Initial TI costs – Total TI allowance = reduced TI costs
Can tenant improvements be expensed?
If the building owner is responsible to pay for the tenant improvements, he or she will account for this capital expenditure as an asset, and the expense will be recorded through asset depreciation over the improvements’ useful life. In the case where the tenants pay for and own the improvements, they will be required to include the allowance as a capital expenditure and amortize this amount over the lease term. With tenants, amortization is used rather than depreciation considering the fact that the building owner ultimately owns all of the improvements (since the changes are physically tied to the building). So, in short, the landlord pays for the improvements and expenses them with depreciation, whereas the tenant pays for the improvements and expenses them with amortization.
In general, tenant improvements are capitalized or expensed based on the value of the changes added. A capitalization limit is set to mark the threshold below which the improvements are expensed and above which they are capitalized and amortized. If the tenant improvements pass the “qualified real property” requirements under IRC Section 179, they can be expensed immediately.
Let’s say that as a building owner, you pay for tenant improvements on a single-floor office of a multi-story building as well as for improvements on a separate restaurant building. You will expense the tenant improvements for the single-floor office but capitalize those for the restaurant building. This is because the restaurant improvements are significantly greater and add more value to your property compared to the single-floor office with fewer, short-term enhancements.
Can you write off tenant improvements?
If you are the tenant paying for and owning the improvements, you will record your allowance as a capital expenditure and amortize it over your lease term. No salvage value applies here as the building owner will eventually own the improvements when you leave at the end of your term – and if your term is too short, you will write off any outstanding balance for the improvements. Even if the owners tear down the improvements, they are required to continue depreciating the remaining basis if the depreciation span of 39 years is used. In contrast, as a tenant, you are allowed to write off your tenant improvements at the end of your lease assuming that you no longer hold any interest in these improvements.
Tenant improvements do not always get fully depreciated by the end of the lease. This usually happens when tenants move out sooner than expected, in which case, they are expected to write off the non-depreciated TI costs as part of their lease termination. Similarly, if you are the owner paying for tenant improvements that eventually have zero value at the end of the term, you can write off the remaining non-depreciated TI costs. It is always best to sit with real estate experts and tax advisors to guide you from early negotiations to the lease termination write-off stage, as they can guide you based on your specific commercial standpoint.
What are examples of tenant improvements?
Tenant improvements refer to all physical customizations that allow a leased building to be usable and functional to its current tenant. So, these are tenant-driven changes and can include HVAC upgrades, MEP alterations, paint refreshing, carpeting, wallpaper addition, flooring replacements, workstation layouts, the addition of break rooms, and so on. Not all customizations count as tenant improvements. This is because the building owner will only approve and pay for those changes that benefit the property in the long run and can be potentially reused by future tenants. Therefore, “volatile” things that can disappear with you when you leave are not included under tenant improvements.
For example, tenant-specific equipment like dental chairs, medical lighting, custom furniture, electronics, and fixtures are all removable objects that hold no interest for the building owner – nor other tenants who will naturally prefer choosing their own furniture and equipment. Tenant improvement allowances also cover only the physical and applicable TI changes like wall painting and carpeting, and they do not extend to cover costs for furniture, fixtures, and equipment.
What improvements must be capitalized on a rental property?
Any tenant improvement that increases the property’s value or extends its life should be capitalized. These are usually those heavy-duty improvements that require specialized labor, which also makes them more expensive. By capitalizing these valuable costs, you can recover them after a certain duration through depreciations and amortizations. Once your property is ready to be leased, you have to decide which repair expenses need to be capitalized and which ones should be expensed based on what the new tenant wants from the space.
As an example, repair and maintenance expenses for fixing an HVAC unit, replacing a small part of the roof, updating a few tiles, replacing damaged parts, etc. are all considered to be short-term expenses that ensure the smooth, day-to-day functioning of your building. They do not add any significant value to the property, so they should not be capitalized.
On the other hand, capital improvements that support structural additions, restorations, adaptive reuse, and betterments add value to the property AND increase its lifespan. They may include adding a deck, creating an extra room, remodeling the kitchen, updating HVAC systems, replacing a significant aspect of a building (like the whole roof), installing sprinklers, installing storm windows, renovating a building after a disaster, converting a warehouse into an office, and so on. The costs for these improvements on a rental property must be capitalized. The IRS also requires capitalizing all such expenses that facilitate building improvements, restorations, building expansions, and adaptations for new commercial uses.
How long do you depreciate tenant improvements?
Tenant improvements are physical assets of a building, which is why they get capitalized and depreciated over their useful life. Generally, the useful life of most tenant improvements is 5 to 15 years; however, depreciation rules can differ based on the financial standard you follow – like the US Generally Accepted Accounting Principles (GAAP). According to the IRS rules, tenant improvements get depreciated for up to 15 years, and this depreciation schedule should be updated every year to reflect the applicable tax and depreciation laws. Before the 15-year rule, the depreciation schedule was 39 years – except for the qualified leasehold improvements (QLIs) that were depreciated over 15 years.
What is a reasonable tenant improvement allowance?
Tenant improvement allowances are driven by various factors like material costs, labor fees, building type, buildout scope, and so on. On average, building owners offer $25 to $40 per square foot for basic first-generation spaces. If the space is second-generation, a reasonable TI allowance would be around $20 per square foot for standard finishes. The difference between both allowances is that first-gen buildings have never been improved before, so they require a more extensive fit-out process.
Second-gen buildings were already occupied by previous tenants, which is why they are better equipped in terms of utilities and functionalities, causing the allowance range to be less than their first-gen counterparts. Negotiating a good allowance amount will help you cover most if not all of your tenant improvements, and you can opt for amortized TI allowance to increase the room for some extra funding.
Building owners need to consider various aspects to both ensure a successful lease and get excellent returns on their investments in the coming years. The higher the real estate compatibility of your improvements, the more the chances of securing a good TI allowance. In addition, longer leases garner more generous allowances because they ensure regular rents for the owner for the next consecutive years, so this is a huge incentive for most owners to pay a greater allowance if it means that you will stay for long.
How do you calculate tenant improvement amortization?
Tenant improvement amortization combines the benefits of an allowance and a loan to streamline funding for your project. It breaks down the loan offered by your building owner into multiple installments, allowing you to pay the owner back part by part until the end of your lease. To calculate TI amortization, the loan you get will be added to your rent along with an interest rate according to the owner’s decision. This is then divided by the lease duration, and the frequency of annual payments is also confirmed. You can always use Google Sheets templates to automate this calculation.
There are also online calculators like the tenant improvement amortization calculator by Austin Tenant Advisors designed to provide accurate amortization values. You just need to enter details like the total loan, the term of the loan (in months), the frequency of payments, and the interest rate. The online calculator will then display your amortized amounts to be paid back to the owner.
Are tenant improvements hard costs?
Tenant improvements are primarily hard costs and include some key soft costs as well. Hard costs make up around 85% of tenant improvements, whereas soft costs only cover around 12%. Some examples of hard costs within TI projects include flooring installations, MEP upgrades, HVAC settings, windows/doors installations, framing, and so on. These are physical customizations that add value to the rented space and make it more functional.
Soft costs, on the other hand, will cover essential fees required to get the project going – like the permit fees, legal fees, management fees, drawings, plans, etc. Although tenant improvements are a mix of both these costs, only the hard costs are eligible for TI allowances, as the owner is interested in only those alterations that enhance the building’s functionality and value.
How much does it cost to design an office?
Office design can cost around $2 to $6 per square foot, which is nearly $60 to $100 per hour in terms of contractor fees. You will work with various experts like architects and interior designers to get your office design right, effective, and code compliant. Mechanical, electrical, and plumbing (MEP) experts will also join in to supervise the framework aspects to ensure their compatibility with your office’s design. In some cases, the design fees for all of these experts combined can extend to around $15 per square foot depending on the size of your project and its complexity. Other key factors that influence these costs include location, material/labor availability, and the type of experts needed for the project.
You will start with 3D drawings and other digital visualizations of your office, all of which will get refined and improved until everything from building codes and interior layouts to paint colors and furniture placement gets sorted. Small-scale tenant improvements need fewer crew members than large-scale projects, so the overall design masterminds involved in the project will also affect your final costs to design an office. If there are reworks involved in the design, especially after inspections and approvals, then this can introduce additional expenses as well.