A DISCUSSION ON TENANT IMPROVEMENTS

Have you ever walked into an office and were immediately impressed? The image of the space; the floors, ceilings, lights, reception area and maybe a glass walled conference room…what about a great looking restaurant or high end warehouse showroom? Tenant improvements (TI’s) play an important part in establishing a company’s image. They’re also one of the most important terms to be negotiated in a lease transaction. Why is that? Primarily because TI’s can be expensive so, who pays for them? Also, the construction phase can be time consuming and potentially impacts lease commencement dates. Whether it’s an office, retail shop or industrial building the costs of construction may be different but discussion about what TI’s are and how much they cost are the same.

What are tenant improvements and how much do they cost?

Tenant improvements can be as minor as new paint and carpet, all the way to constructing a brand new office suite. Design styles and materials vary greatly in price as does the cost of construction from builder to builder. Typically when discussing TI’s the cost is stated in a per square foot basis. For example, someone is getting $20 per square foot of TI allowance for a 2,000 square foot office suite, would have an allowance equaling $40,000. A clean, rather generic office space with basic materials will cost much less than a high image law firm or doctor’s office which may require well above $100/sf.

Knowing roughly your design requirements and having an initial cost estimate is important because who pays the cost of the TI’s comes up very early in the lease negotiation. Generally speaking the TI’s can be paid by the landlord, by the tenant, or a combination of both, so let’s briefly discuss all three

Landlord pays for the improvements

Landlords can do this two ways; one, build the space out themselves, per a mutually agreed to space plan, and provide the tenant with a “turn-key” space, meaning the landlord is responsible for the entire construction project and once complete gives the keys to the tenant to move in.

Aside from specific design and materials inputs, the tenant is completely out of the construction process. A positive of this scenario is all the responsibility lies with the landlord. Conversely, the tenant has no control over the schedule so any delays will potentially impact move-in dates. The second way the landlord could cover costs is by providing a TI allowance to the tenant. In this case the tenant is responsible for all phases of construction, including initial payments. The landlord then reimburses the tenant the amount agreed to in the lease. A positive of this scenario is the tenant has more control over the costs and schedule. The schedule can be a double edged sword, as they would also be responsible for any delays. If not negotiated properly, delays may extend beyond the lease commencement date. Landlords view TI allowances just like paying commissions, as an operating cost of owning a building. Reserves are set aside for these specific items and for accounting purposes are factored into the costs of the property even before they are disbursed. It should be noted as well that in the event of a tenant default on the lease, the landlord may require a reimbursement of any remaining amount of the original allowance which is typically amortized over the lease term.

Tenant pays for the improvements

In this scenario the landlord has little or no involvement in the process aside from agreeing to the design and ensuring the contractor is legitimate. It behooves the tenant to hire a licensed, bonded contractor to ensure the landlord the work will be done correctly and conform to all municipal building codes. Maybe the landlord delivers the space to the tenant in an “AS-IS” condition, meaning absolutely no prep work has been done, or they provide the space with some level of demolition of the previous tenant’s improvements. Regardless of condition, the cost and responsibility falls on the tenant for everything involved in the construction process. Generally speaking the tenant will take a loan out for the costs of the TI’s. There are several loan programs to pick from including SBA (Small Business Administration) financing. Although this is not a guarantee, the initial, and potentially costly, investment needed to relocate and improve the space may be negotiated and balanced against a landlord concession of equal value.

Landlord and Tenant pay for the improvements

In this scenario the landlord may offer a certain amount of allowance and the tenant covers any costs beyond that. As mentioned above, the landlord may also choose to be responsible for some or all of the demolition if required to remove any existing improvements in lieu of actual cash out of pocket. In this scenario the landlord may choose to use a contractor of their choice or let the tenant make that decision.

Every business is different and every TI will be different so tenants need to understand what is involved both financially and logistically with the construction of their improvements. The more they know the better they are able to budget and plan their project. The improvements go a long way to portray the appropriate corporate image to employees, clients, and the business community. Our goal at Botticelli Realty Advisors is to educate tenants on every aspect of a commercial lease transaction. The better informed tenants are the better business decisions they make. If you have any questions about tenant improvements or would like to discuss your current lease situation, please do not hesitate to contact me at (760) 445-9908(760) 445-9908. Please visit our website as well to learn more about Botticelli Realty Advisors at http://www.bradvisors-sd.com.

Thank you,

Brian Lukacz