Understanding Your Commercial Lease: Tenant Improvement Allowances
Tenant improvement allowances are often one of the most important issues for a new tenant when finding and negotiating a commercial lease, especially when the tenant is a start-up. In basic terms, the tenant improvement allowance is the amount of capital the landlord is willing to put into the space for the specific requirements of the tenant’s particular use of the space. Another way of saying it is that tenant improvement allowances are the amount of money the landlord will spend to alter the structure, including on building walls and other partitions, modifying building systems, like plumbing, electrical, and HVAC, and making common space adjustments to facilitate your intended use. “Tenant improvement allowance” can mean many different things, but they are all basically a description of the landlord’s investment in your specific business’s improvements to the space as an incentive for you to sign the lease.
The tenant improvement allowance amount is an economic term that good brokers will help you understand and leverage early in the commercial leasing process. The tenant improvement allowance is generally a function of the type of space, the value of the modification to the landlord (particularly if you were to leave and the landlord had to find another tenant), your creditworthiness as a tenant, and the term of the lease.
Tenant improvement allowances are generally delivered by the landlord through the landlord’s “building out” the space. So you will want to understand what oversight you have to spend the tenant improvement allowance money as you please on making the space your own. Generally, the landlord will give you specific parameters for how the space will be built out and will reserve the right to choose all major players in the design and construction of your space, including choosing the general contractor and architect. The landlord will also try to ensure you will be on the hook for any delays, overages, and other build out risk. Your lease will generally describe tenant improvement allowances in a separate work letter, and they may also be described and affected by the “alterations” or similar clauses in your lease.
A savvy tenant will negotiate for outs if the landlord does not follow through with getting the tenant improvements finalized on schedule, and will also negotiate to have a choice in terms of who the landlord hires to build out the space and by extension how much the build out will cost.
A substantial tenant improvement allowance can help add instantly to your business’ credibility and ability to operate efficiently, so the tenant improvement allowance can be incredibly valuable. Customers and employees will react much more favorably to having an updated and comfortable space, and you may not be able to fund what is required upfront to provide that environment without the landlord’s help. So having a landlord who provides a tenant improvement allowance is much like having an investor who is banking on your future success. However, tenant improvement allowances almost always require some type of credit enhancement, whether it is a personal guarantee, a letter of credit, or an increased security deposit.
Tenant improvement allowances allow well-funded landlords to attract quality tenants and increase their chance of renting an otherwise marginal space—tenant improvement allowances can be used by landlords to finance the overhaul of outdated spaces, which provides another incentive for landlords to take the risk on building out a building for a start-up tenant.
A tenant improvement allowance can help your business get a jump start on a new space. But beware of “hidden” costs of build out and who takes on the risk that the tenant improvement allowance isn’t enough to facilitate your intended use.