Leasing 101: Tenant Improvement Allowances

A landlord likely will offer a prospective tenant certain financial incentives to attract the new tenant. As part of these financial incentives, the landlord may include a tenant improvement allowance, which is an amount of money that the landlord provides the tenant for its construction and decoration of the premises.

Payment

If tenant is receiving an allowance from landlord to build out its leased premises, tenant almost always will have to first pay for the construction costs before being reimbursed by landlord for the allowance amount. The payment method can be negotiated. The allowance can be paid in installments or all at once. An approach often used is to have landlord make a payment when construction begins and then make additional payments during the construction period as tenant incurs expenses, with a final payment once the store opens. Tenants should be aware that they likely will have to provide the landlords with the appropriate lien waivers and other construction documentation.

Landlord Clawback

Tenants also should be aware of attempts by the landlords to claw back the tenant improvement allowance in the form of overhead, supervisory, or other administrative fees in relation to the tenant construction. By prohibiting these charges in the lease, a tenant can protect itself from these landlord fees.

Alternatives to Cash Allowances

Although landlords might be inclined to provide competitive tenant improvement allowances to lure tenants, it is worth noting that they may not have the available cash to provide this. Other options in lieu of an improvement allowance include adjustments to rent. A tenant may be able to negotiate a lower monthly rent or a temporary rent abatement, which may result in a better lease deal to the tenant from a financial perspective. A broker can help negotiate these provisions.

Tenant Set Off Rights

Since tenant almost always will have to first pay for the construction costs before being reimbursed by landlord for the allowance amount, there is a risk that landlord may not reimburse tenant for these costs. The landlord may dispute the costs or may be short on funds because of financial difficulties. Having to carry these unexpected construction costs could be financially disastrous to a tenant.

Therefore, a tenant can protect itself by inserting a clause providing for a set off of the tenant improvement allowance. If landlord does not reimburse tenant within a certain time period after tenant presents all required documents for reimbursement (e.g. 30 days), this clause would allow tenant to offset the tenant improvement allowance against rent coming due. A tenant should also be aware that any abatement for rent at the beginning of the term might delay feeling the effect of this clause. This would mean that a tenant would not be fully reimbursed for construction until the future rent equals the construction costs, but it does provide for an efficient, non-litigation remedy for repayment.

A landlord may want to limit the amount a tenant can offset each month. A landlord may propose that tenant can only offset the tenant improvement allowance against 50% of the rent coming due each month. This would allow landlord to receive a certain amount of cash flow each month. However, a provision like this is tantamount to landlord being a lender to tenant for its construction costs, and a tenant should attempt to refuse this provision.

For more, please visit Tenant Leasing 101 on Amazon here.