Despite the pandemic’s continuing effect on the Texas economy, many experts believe commercial real estate (CRE) developers are well-positioned for recovery. In Deloitte’s latest survey, 80% of respondents expect CRE revenues in 2022 will be slightly or significantly higher than last year.
A key for improvement is the ability of large-scale landlords to attract and retain high-quality commercial tenants. One popular incentive – especially when vacancies increase – is to turn prospective renters into long-term tenants by negotiating a smart tenant improvement (TI) allowance.
How do they work?
TI allowances are typically part of a commercial lease agreement where landlords provide a sum of money to customize an office or retail space to meet the tenant’s business needs. Both parties negotiate the allowance along with the rent amount and length of the lease. Tenants do not have to pay back a TI allowance.
The sum is usually based on cost per square foot – usable vs. rentable space – generally ranging from $15 to $40 per square foot. However, the rate depends on several factors, including the location, the property’s condition, length of the lease and the local real estate market. You should also consider the tenant’s credit and leasing history.
What TI allowances should and should not include
The allowance can be quite costly. If you lease a 10,000 square foot space and agree to a cost of $30 per square foot, you will spend up to $300,000 for a build-out. This can be money well spent if it helps you attract a quality tenant and improve the property’s value.
Landlords and tenants generally differ over what to include. Landlords understandably prefer limiting a TI allowance to cover the hard costs of the renovation, including labor and materials. Tenants often want to include costs for architects, permits and legal fees.
While landlords must decide which items to negotiate on a case-by-case basis, TI allowances should avoid covering specific tenant expenses. These include office furnishings and décor, cabling, internet, moving expenses and other “soft” costs that do nothing to increase the property’s value.
Craft a clear and beneficial agreement
Offering a TI allowance can be a crucial incentive to find good tenants. While construction costs can be expensive, many consider it part of doing business. It is advisable to seek experienced legal guidance for crafting all aspects of a worthwhile lease agreement.
Your lawyer can identify any potential risks and benefits, plus address essential details. These considerations include whether any unused funds from a TI allowance can be put towards future rent as an added incentive or returned to you to upgrade your property.