Negotiating Tenant Improvement Allowances in an Office Lease

The contributions made by landlords to tenants signing an office lease to build out the space are known as Tenant Improvement Allowances. In a renter’s market, landlords offer incentives to desirable prospective tenants.

The money the landlord is willing to spend can be either a lump sum or on a per-square-foot basis. The expenses for which the allowance will be used should be clearly defined in the office lease. The landlord might limit the Tenant Improvement Allowance to certain items that will offer lasting benefits to the property. On the other hand, tenants might want to utilize the allowance for managing projects, designing the space and infrastructure, and personal items such as furniture or other equipment. The control of the build-out must be negotiated at the outset. Tenants should present an accurate forecast for the renovation by consulting contractors and architects before the meetings for the negotiation.

Tenant Improvement Allowances can either be for a fixed amount or capped at a maximum amount. If the amount is fixed, rent credit, or payment, it should be specified in the office lease. Often the landlord does not want to pay for all the improvements the tenant wants to make, so both parties invest some money and have “skin in the game.”

Since tenants may need the allowance upfront, a payment schedule or timeline must be negotiated based on monthly disbursements. It should be specified in the office lease whether the payments are being made directly to the contractor or the tenant. Frequently the contractor is hired by the landlord, as they have a thorough knowledge of the building.

If the tenant has concerns regarding the financial condition of the landlord, they may require security in the form of a guarantee or a letter of credit. Likewise, the landlord needs to ensure that the tenant has enough funds for construction and is creditworthy. It should be mentioned in the lease that if the tenant fails to complete the construction, they will have to pay the original amount back to the landlord. The tenant may also have to offer some bond or money in the form of security to the landlord.

Landlords are advised to add a clause to the lease demanding that the financed changes become their property when the lease term ends. The landlord can then treat the Tenant Improvement Allowance as a capital improvement for tax purposes. There are many benefits to the landlord for building the space when entering into an office lease. Office tenants should not treat this as a generous gift but realize they have a right to the tenant improvement allowances. They should negotiate the best terms to take full advantage of this incentive.