The tenant improvement allowance is part of an overall incentive package provided by a landlord to either attract a tenant to their building or retain a current tenant as part of a lease renewal. Here are three things to remember when negotiating an improvement allowance:
1. The tenant improvement allowance is amortized into the lease rate. Landlords view the financial terms of a lease as one big bucket of income and expenses. If the landlord increases the allowance amount, that may limit their ability to negotiate the rental rate and other financial concessions like free rent.
2. Turn-key allowances shift cost exposure to the landlord, and the construction project and specifications are defined in the lease. The landlord is responsible for delivering the space on time and on budget. All costs for construction lay solely on the landlord. If there are cost-overruns, the landlord is responsible for absorbing the additional expense. But if the landlord can value-engineer the project, he can keep any savings as additional profit.
Something to remember about turn-key: It behooves the tenant to be very specific with regard to expectations for construction during the lease negotiations.Tenants should insist on as much detail as possible being included in the lease to ensure that expectations are met and there are no disputes during the construction process. This detail should include an architectural drawing of the space and a complete list of finishes, all the way down to the door handles.
3. Fixed allowances shift savings opportunities to the tenant. providing the tenant with an opportunity to capture any unused allowance and use it to offset rent. But if there are construction cost over-runs, the tenant is responsible for absorbing those additional costs.
Something to remember about fixed allowances: Be sure to define “base building conditions” when using a fixed allowance. Will the landlord deliver the space with a ceiling and HVAC system in place? Where is the electrical panel? Will a submeter be installed by the landlord or is that the tenant’s responsibility? Who is paying the demising costs?
Both structures have their advantages and drawbacks. A good real estate broker should help their client understand which is a better choice based on the specific situation.