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Understanding Tenant Improvement Allowances and Turnkey Build-Outs

December 20, 2017

The tenant improvement allowance (TI) is one type of incentive offered to you when you’re searching for commercial space to rent. This allowance differs from a turnkey lease arrangement where all improvements are made prior to your lease term. Like everything else related to leasing commercial property, TI agreements and turnkey build-outs are complicated.

Manage TI offers and turnkey agreements by first understanding the concept of both types of improvements and the value they add to your business. Here’s what you should know.

TI Terms Vary By Landlord

TI offers may cover a new coat of paint and fresh carpeting in the office. They may also cover new cubicles, upscale wallpaper, and break-room appliances. Some agreements stipulate that the landlord pay the contractors a certain dollar amount to cover the costs of improvement.

Other TI agreements take a percentage off of the tenant’s monthly lease amount. In cases like this, the tenant uses the difference to finance the improvements to the property.

If you’re searching for space in a tight commercial property market, don’t expect many offers of TI allowances. Generally, you’ll find the most generous TI offers in areas where there are above-average vacancies in commercial space. In hotter markets, look for TI offers when leasing older properties that need significant improvements.

Property managers can steer you to properties that include TI arrangements, especially if those properties are not moving or are located near brand new office complexes. Leasing agents and property managers can also help you locate buildings and office spaces that include a turnkey build-out.

Turnkey Build-Outs Are Sometimes Best

If your needs are simple and the commercial space has all or most of the features your business requires, a turnkey build-out may be in your best interest. You aren’t saving money if your business doesn’t really need a fountain, stone floors, and a new ceiling. You’re better off negotiating for a lower monthly rent amount than for fancy new digs.

Turnkey build-outs are more popular in tenant’s markets. In some cases, experts warn that you may receive lower-quality construction and materials when you leave it to the landlord to fix up the commercial property for you. To protect yourself, have all expected improvements spelled out clearly in writing and included as part of the lease agreement.

If your business is a medical office, restaurant, or other specialty concern, a turnkey build-out may not be in your best interest. Corners may be cut on key equipment. Crunch the numbers to determine how much you realistically need to invest to properly run your business in a given location. If the landlord is offering you too sweet of a turnkey deal, suspect that the quality of your services or product may suffer.

Having a Strategy Helps You Negotiate the Best Agreements

Allowing the landlord to supervise your commercial-space improvements makes a lot of sense for several reasons. You save time when you don’t have to source contractors and open and close the building for them. The landlord will have power and other utilities available for the contractors. The landlord also understands:

  • What’s required in the local building code
  • Where the building’s utilities are located
  • How to minimize disruption to other tenants
  • Where weight-bearing walls are situated

Negotiate the best deals in a landlord-controlled improvement project by having a clear work order as noted above. Ask the landlord to undergo a bidding process. Have the contractors submit bids and the landlord open the bids in your presence as proof of the amounts quoted.

Agree to have the landlord check with you at key steps in the build-out or upgrade project. Include a clause in your agreement that allows your project manager to change or upgrade materials before final approval is given for key business features.

Fine Print and Accountability Are Expected

Double check the fine print on agreements. Most landlords will charge you for any related permit and administration fees when they oversee your improvements. You may also be responsible for any lawyer, architect, or engineer fees if there are significant changes made to the structure you lease.

Accountability clauses are also common in TI agreements and turnkey build-outs. In this type of agreement, damages must be paid by you if the building is not ready on time. If you take too long to finish improvements and you’re disrupting other tenants after a specific deadline, you’re required to pay a penalty for every day you go over the deadline.

Likewise, there are penalties for cost overruns. There are agreements about what to do if the landlord has TI money left over after your requested improvements are made. In some cases, the tenant receives the surplus TI funds. In other cases, the agreement allows the landlord to keep the excess.

File and store all commercial lease agreements securely. You need digital and/or paper copies for tax purposes. Depending on the lease agreement, you or your landlord can normally claim depreciation on improvements.

If the landlord is paying you back for improvements in a “flow-through” arrangement, you have no fixed-asset to claim. In some cases where cash is paid to you as a tenant, you must claim the payments as a lease incentive on your business tax return.

For more information on the difference between TI allowances and turnkey build-outs, contact the experts at Hartman Income REIT Management, Inc.