Tenant Improvement Allowance Negotiations: What You Need To Know
Gym’s offer free trial memberships in order to entice new patrons. Beer companies offer free t-shirts or hats as a way to sweeten the deal when buying a case of their product. We all appreciate a good old fashioned consumer incentive, don’t we? Landlords also offer incentives along the same lines in order to attract prospective tenants to fill vacant office spaces, and navigating these negotiations is a hugely important aspect of lease agreements.
The most coveted landlord incentive is the tenant improvement (TI) allowance — an agreed upon amount the landlord is willing to pay for to renovate or retrofit the space for a tenants specific needs. Typically, TI agreements are inked with per-square-foot parameters, or alternatively, a lump sum amount – but key to understanding this incentive is knowing it’s decided during lease negotiations.
Lease negotiations often include talks about who ultimately gets to decide on a final design, who does the work, and who pays for it all; in this post, we’re looking at what you need to know about tenant improvement allowance negotiations.
Your Goals as a Tenant
Tenants negotiating a new lease agreement for an office space would much rather have the space fitted to their needs, without having to pay out of pocket to make the changes. Tenants negotiating their improvement allowance terms should be prepared to fight for two specific aspects of the deal:
- Get an allowance large enough to cover the improvements you deem necessary to your business.
- Maintain a high degree of control over the build-out process, including who does the work, and the final design.
These goals should determine the scope of your discussions with your prospective landlord, and you should expect to discuss in detail, how you’ll achieve this agreement, which will probably be structured in one of two ways.
A turn-key build-out is when the landlord agrees to cover all the costs of a tenant build-out project as part of the agreed upon lease arrangement. This style of deal sometimes means the scope of construction is agreed to, but how it comes to fruition may not be under the control of the tenant. Simple, but sometimes not specific of prompt as envisioned.
Next is a stated dollar amount wherein the landlord will agree to provide a stated dollar amount for the prospective tenant group to use towards building out the space for their needs. This can mean construction costs, architectural, or engineering fees, resulting in the tenant remaining in control of the build-out process, knowing full well their budget, and the contractors and groups doing the work.
Both ideas have their merits, but like any deal, it’s all about educating yourself and finding ways to benefit from your negotiation skills.
Issues with Turn-Key Agreements
In short, with turn-key agreements, a landlord may agree to a set amount of money from which to complete a build-out, and then incorporate a level of contingency costs to prevent the real-life costs of the project from exceeding the estimate. What does that mean in plain english? Some landlords are notorious for cutting corners when given the green light on turnkey agreements in an effort to save their out-of-pocket expenses.
Let’s imagine you agree to a $30/square foot estimate with your landlord for a turn-key tenant improvement allowance deal. If the landlord is able to finish the space and only spend $20/square foot, they’ll eagerly accept that price, and deliver a turn-key space that is effectively worth $10 less per square foot, negatively affecting the tenant who thinks they’re benefiting from a $30/square foot renovation. The landlord spends less, negotiates a higher rent number to compensate for their spending, and effectively double dips and profits from this arrangement.
Secondarily, the nature of the turnkey arrangement is, the tenant forfeits control of the build-out process, leaving the hiring, design, and construction of the renovation solely in the hands of the landlord.
Pro Tip: head to the negotiation table with an extensively researched and documented work letter, detailing a specific set of construction plans so you know what you’re getting for the agreed upon price. Without these plans, what you see is often what you’ll get for your negotiation efforts.
Negotiating a stated amount deal is key to tenants maintaining control of the build-out process. With a stated amount deal, tenants may be able to negotiate the right to retain their own project manager and ultimately oversee the design and build phase of the renovations or remodelling.
Objectively, this is all about shifting control from the landlord to the tenant to ensure quality control over the process, as well as to prevent or intervene during any potential time setbacks to prevent holdover rent/lease fees.
If negotiated properly, a stated amount deal also guarantees the tenant group is able to proactively negotiate and select a contractor group that gets them the best value for the dollar amount agreed to in the terms of the tenant improvement allowance agreement. This guarantees any savings directly benefit the tenant, not the landlord.
It’s not necessary, but it’s always wise to negotiate the right to amortize new tenant improvement allowance dollars into the agreed upon monthly rent so you may add potential improvements down the road, should you need them.
Negotiating will be easier, and more effective if you know the scope of your desired build-out specifics ahead of time. Bring with you an accurate price estimate for what you’re after so you can negotiate a fair stated amount deal, or an accurate turn-key budget that you collectively agree the tenant should co-manage.
During your negotiations, get in writing what overhead charges your landlord seeks to charge you as part of any tenant improvement allowance deals. Landlords will charge ‘administrative’ fees for tenant improvement work to lessen the amount of money they need to spend on actual improvements, ultimately becoming a source of revenue for them.
Find out what fees and charges the landlord seeks to charge before agreeing to any deal, and consult a real estate broker or neighbouring tenants to make sure they’re sticking to local customs and norms.
It’s easy to sit down at the negotiation table with visions of tenant world-domination on your mind. There’s an element of perceived power we associate with negotiating the best deal possible, and it’s important for any prospective tenant to consider – but it’s not always necessary.
Should your build-out entail a few minor walls being moved, a new floor, and a fresh coat of paint, it’s not that important the tenant group maintain total control over the job; it’s simple enough that it doesn’t matter too much how the work gets done, as long as it serves your business well. It’s when a build-out means structural changes, architectural considerations, and custom renovation features that control should be harshly fought for by the tenants.
Any way you spin it, maintaining control over your improvement allowance deals allows tenants to maximize the value of their deal, and minimize potential hiccups of interruptions in the future.