ITRA Global News

Tenant Improvements and Risk Avoidance

September 13, 2023

Tenant improvements and tenant improvement allowances are provided in many leases. How these items are provided depends on the building, the landlord, the market, and the tenant. 

In tight market conditions, the landlord will generally stipulate how much they will provide for a tenant improvement allowance and specify how it will be paid out. They could also define certain elements that they will pay for in the space, and then the tenant is responsible for all improvements beyond that. This type of structure carries risk for the tenant because cost overages become their responsibility. Potential risks are not limited to just the construction cost, as there are also potential cost overruns pertaining to architectural design costs, permitting, and potential municipal utility access charges for water and sewer services.

In equilibrium market conditions, the scenario above is the norm. However, terms are more negotiable with the landlord and the tenant may be able to get a larger improvement allowance or more improvements from the landlord.

One concept available for tenants to help cover construction costs is called “amortized improvements.” This is essentially a loan from the landlord that is added on top of the rental rate and is paid back over the lease term. Keep in mind that the landlord’s interest rate is typically higher than what a bank would charge.

In soft markets where tenants have negotiating leverage, it may be possible to push construction costs and cost risks onto the landlord. One type of structure is referred to in the industry as “turnkey” improvements. This means the landlord agrees to pay for all improvements regardless of the cost. The landlord will get a construction cost estimate before the lease is signed of course, but they will be responsible for any additional surprise costs that come up (and they usually do in construction!) This is an ideal structure for the tenant to avoid risk, but it is critical for them to define the scope of the work in a detailed fashion to ensure the landlord doesn’t cut corners to save money.

There are many ways to structure tenant improvements depending on the scope of the job, the landlord, and timing requirements. When you are considering a lease renewal, new lease, or expansion of your space that will involve construction, you should speak with an ITRA Global advisor to help guide you through the entire lease process (including construction) to ensure your needs are met. Find a local ITRA Global advisor here.

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Article submitted by Wayne Teig / ITRA Global Minneapolis-St. Paul, Minnesota USA


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