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What Is a Tenant Improvement Allowance?
A TI allowance is an incentive offered by many commercial real estate owners to cover the costs of customizing space for a tenant's needs.
A tenant improvement allowance, also known as a TI allowance, is an amount of money provided by a landlord to a tenant to pay for the cost of improvements to a commercial property. The landlord typically provides the tenant with a lump sum payment or a line of credit to cover the costs of the improvements. This allows the tenant to customize the space they are renting to suit their needs while the landlord is able to maintain control over the quality and cost of the improvements.
Tenant improvement allowances are commonly used in commercial real estate leases, particularly in office, retail, and industrial properties. It is important to understand how they work and how to set a favorable allowance that will help you attract and retain long-term tenants.
What Are Tenant Improvements?
Tenant improvements, or TIs, are modifications or additions made to a leased commercial property to make it suitable for the tenant’s use. This can include anything from minor changes like painting and carpeting, to more significant and permanent modifications like installing new walls, plumbing, or electrical systems. Common tenant improvements include:
Painting and wall coverings
Flooring
Lighting and ceiling fans
Windows
Doors and hardware
Cabinets and countertops
Plumbing and electrical systems
What is a tenant improvement allowance?
A tenant improvement allowance is the maximum amount of money a landlord will cover for a tenant to improve the rentable space within a commercial property. TI allowances cover a broad spectrum of improvements, mostly on the building’s interior. The amount of the allowance will vary depending on many factors, from the market to the asset type. It also may depend on the type of lease. A triple-net lease may have a different level than a full-service commercial lease, for example. Beyond this, the amount is also generally a point of negotiation between a tenant and a landlord.
TI allowances are typically expressed as a value per square foot of a lease when marketing space to lease. However, it may be more useful for a landlord to look at the cost as a percentage of the annual rental income generated by the lease agreement.
Tenant improvements, or TIs, are modifications or additions made to a leased commercial property to make it suitable for the tenant’s use. This can include anything from minor changes like painting and carpeting, to more significant and permanent modifications like installing new walls, plumbing, or electrical systems. Common tenant improvements include:
- Painting and wall coverings
- Flooring
- Lighting and ceiling fans
- Windows
- Doors and hardware
- Cabinets and countertops
- Plumbing and electrical systems
Tenant improvements are an important factor in commercial real estate leases, as they can significantly affect the cost of a lease. A TI allowance gives a landlord a way to incentivize a tenant to sign or renew a lease while improving the property.
Note that a tenant improvement allowance represents the maximum amount a landlord will cover. If a TI allowance is set at $15 per square foot and a tenant spends $20 per square foot, the landlord’s contribution will not change unless specifically agreed to in advance.
How does a tenant improvement allowance work?
A tenant improvement allowance is the maximum amount of money a landlord will cover for a tenant to improve the rentable space within a commercial property. TI allowances cover a broad spectrum of improvements, mostly on the building’s interior. The amount of the allowance will vary depending on many factors, from the market to the asset type. It also may depend on the type of lease. A triple-net lease may have a different level than a full-service commercial lease, for example. Beyond this, the amount is also generally a point of negotiation between a tenant and a landlord.
TI allowances are typically expressed as a value per square foot of a lease when marketing space to lease. However, it may be more useful for a landlord to look at the cost as a percentage of the annual rental income generated by the lease agreement.
The amount of a tenant improvement allowance offered to a tenant will vary depending on the type of property and your tenant’s needs. Many landlords will calculate the TI allowances they’ll offer by calculating it as a percentage of the total rent or by expressing it as a dollar value per square foot of the lease.
For example, a property owner may offer a 5% or 10% tenant improvement allowance for a standard office lease, meaning the landlord would cover that amount of the tenant’s annual rent for improvements. Often, for the sake of simplicity, this would be expressed as a real dollar figure — for example, a $20-per-square-foot tenant allowance.
Note that many tenants expect to be able to negotiate this figure. Because of this, it is usually best to have a range you, as the property owner, are willing to accept.
What are the benefits of a tenant improvement allowance?
A tenant improvement allowance provides a number of benefits for both tenants and landlords. For tenants, it can help reduce the cost of improvements to the leased space, making it more affordable to move in or upgrade the space. For landlords, it can help attract tenants and incentivize them to sign or renew a lease, while also improving the property.
In addition, TI allowances can help landlords manage their costs more effectively. By setting a maximum amount for tenant improvements, landlords can ensure that they are not overspending on improvements. This can help them maintain their budget and ensure that they are not spending more than they can afford.
Finally, TI allowances can help landlords and tenants negotiate more effectively. By setting a maximum amount for tenant improvements, landlords can ensure that they are not overspending on improvements, while tenants can be sure that they are getting the best deal possible.
What are the drawbacks of a tenant improvement allowance?
The main drawback of a tenant improvement allowance is that it can be difficult to accurately estimate the cost of the improvements. Tenants may overestimate the cost of the improvements, leading to a higher allowance than necessary. Additionally, the tenant may not be able to complete the improvements within the allowance, leading to additional costs that the tenant must cover.
Another potential drawback is that the tenant may not be able to use the allowance for the improvements they need. For example, if the tenant needs to install a new HVAC system, but the allowance only covers painting and wall coverings, the tenant may not be able to use the allowance for the improvements they need.
Finally, the tenant may not be able to use the allowance for the improvements they want. For example, if the tenant wants to install high-end finishes, but the allowance only covers basic finishes, the tenant may not be able to use the allowance for the improvements they want.
What are the eligibility requirements for a tenant improvement allowance?
Eligibility requirements for a tenant improvement allowance vary depending on the landlord and the type of lease. Generally, the tenant must be able to demonstrate that the improvements are necessary for the tenant to use the space, and that the improvements will increase the value of the property. The tenant must also be able to demonstrate that they have the financial resources to cover the cost of the improvements.
In addition, the tenant must be able to demonstrate that the improvements will be completed in a timely manner and that the tenant will be able to maintain the improvements. The tenant must also be able to demonstrate that the improvements will not cause any damage to the property.
For more information, please see this article on tenant improvement allowances.
What are the tax implications of a tenant improvement allowance?
The tax implications of a tenant improvement allowance depend on the type of lease and the type of improvements being made. Generally, tenant improvements are considered capital expenses and are depreciated over time. However, if the improvements are considered to be repairs, they may be deductible in the year they are made.
For more information, you can read IRS Publication 535 and IRS Publication 946.
Tenant improvements are an important factor in commercial real estate leases, as they can significantly affect the cost of a lease. A TI allowance gives a landlord a way to incentivize a tenant to sign or renew a lease while improving the property.
Note that a tenant improvement allowance represents the maximum amount a landlord will cover. If a TI allowance is set at $15 per square foot and a tenant spends $20 per square foot, the landlord’s contribution will not change unless specifically agreed to in advance.
How Much Should I Offer a New Tenant?
The amount of a tenant improvement allowance offered to a tenant will vary depending on the type of property and your tenant’s needs. Many landlords will calculate the TI allowances they’ll offer by calculating it as a percentage of the total rent or by expressing it as a dollar value per square foot of the lease.
For example, a property owner may offer a 5% or 10% tenant improvement allowance for a standard office lease, meaning the landlord would cover that amount of the tenant’s annual rent for improvements. Often, for the sake of simplicity, this would be expressed as a real dollar figure — for example, a $20-per-square-foot tenant allowance.
Note that many tenants expect to be able to negotiate this figure. Because of this, it is usually best to have a range you, as the property owner, are willing to accept.
Determine Your Leasing Income
You can use our handy commercial lease calculator below to figure out your annual leasing income. This enables you to understand how much the TI allowance could cut into your net operating income.
Differences in TIs Between Property Types
The amount of tenant improvement allowance offered will vary depending on the type of commercial property being leased. For example, retail properties tend to have higher tenant improvement allowances than office properties, since these properties require more extensive modifications to make them suitable for retail tenants. Industrial properties typically require fewer tenant improvements and thus have lower tenant improvement allowances.
The table below is a rough approximation of tenant improvement allowances by asset type. It may appear more useful to express this as a dollar-per-square-foot figure, of course. But, due to wide variation in rents across markets, a percent can offer you a good idea of what you may need to offer in real terms.
Property Type | TI Allowance as % of Annual Rent |
|---|---|
Office | 5% to 10% |
Retail | 10% to 20% |
Industrial | 5% to 10% |
Conclusion
A tenant improvement allowance is the maximum amount of money a landlord will cover for a tenant to improve the rentable space within a commercial property. TI allowances cover a broad spectrum of improvements, mostly on the building’s interior.
The amount of the allowance will vary depending on many factors, from the market to the asset type. It also may depend on the type of lease. A triple-net lease may have a different level than a full-service commercial lease, for example. Beyond this, the amount is also generally a point of negotiation between a tenant and a landlord.
TI allowances are typically expressed as a value per square foot of a lease when marketing space to lease. However, it may be more useful for a landlord to look at the cost as a percentage of the annual rental income generated by the lease agreement.