What Is a Reasonable Tenant Improvement Allowance?
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The post-pandemic era is in full swing, and new opportunities are popping up like daffodils. One incentive on the table for those seeking new spaces for lease is the tenant improvement allowance.
For those just digging into deeper conversations around CRE, tenant improvement allowance (TI) is money passed from landlord to tenant designed for improvement to their leased space.
So, what's reasonable to expect in terms of this allowance? Go in with too high of a number, and you're bound to be disappointed; go in with too low of a number, and you could end up not getting as much allowance as what's really needed to help transform the space to suit the current business needs.
There are a few things to consider in understanding the moving gears underneath the tenant improvement allowance.
The Renovations Matter
Not all renovations are created equal. Some buildings just need a lot more work than others. That's going to be both the hard stuff, like the framing, walls, HVAC, doors, windows, and paint, rather than the “frills,” like new office furniture.
The landlord is looking for things that will improve the space for their benefit as well, not just the tenant renting the space for the time being.
Does Monthly Rent Play a Role?
Monthly rent would absolutely play a role in evaluating the reasonability of the TI allowance. Indeed, if the monthly rent is high over the long term, the TI allowance is essentially “paid back” to the landlord. So it wouldn't make sense to look at these allowances as free money.
They're essentially a retention tool in the long run, as tenants that participate in renovating a space are less likely to just move out of it. It's far more likely that they would renew a lease term with the landlord.
If business is good at the location, there's even more incentive to stay rather than leave and create turnover costs for the landlord.
Post-Negotiation Analysis in Light of Tenant Improvement Allowance
Negotiation of the lease agreement isn't the issue here, and it's important to think about more than just looking at going back and forth with the landlord.
It's time to study the tenant improvement allowance by the metrics against the construction costs.
Lay it out on the table and think about a few things:
- If the TI weren't on the table, would the renovations still be a priority?
- What are the costs that are unique to the situation, things that the landlord wouldn't benefit from? Those items would be restricted from most tenant improvement allowances.
- What are the costs of the total renovation? Break it down by square feet.
Looking at the numbers will help determine what's genuinely reasonable. For example, if the ratio of TI to covered costs is around 70%, that's a pretty good deal.
On the other hand, if there are a lot of additional costs hanging over your head, the TI offered may not be as reasonable as meets the eye.
Ultimately, the reasonable tenant improvement allowance will vary. Some landlords may offer $50 per square foot, which is generous in a lower-cost area compared to a higher one.
There are so many variables that the question has to be taken in light of location, building type, renovations offered, and other elements.
Hot Market #1: NYC Tenant Improvement Allowance Ranges
According to leading research firm JLL, the tenant improvement packages in NYC run around $48 per square foot.
At first glance, this doesn't sound like a lot of money on the table. However, if the total rentable space is around 8000 sqft, that would give an allowance of $384,000.
Considering that money doesn't come from the tenant directly, that's still quite the incentive.
Hot Market #2: LA Tenant Improvement Allowance Ranges
According to Avison Young's recent report, tenant improvement allowances in the LA market have risen by 9% over the last 24 months.
Given the needs of the pandemic, this makes perfect sense. The tenant improvement allowance range in the LA area is between 60 and 80 dollars, which means that anything in between would be considered reasonable.
So, using the same example as above, an 8,000 square foot leased space with a $70 average TI allowance would yield a total allowance of $560,000.
Building Costs Also Play a Role in Tenant Improvement Allowance
One insight that can be drawn from the difference in numbers between LA and NYC would be the different costs involved in building.
The LA market is lucrative but not just for commercial real estate investors, tenants, and brokers. It's also profitable for the developers, builders, and general contractors as the demand is high enough to charge well for their services.
Building a Plan for the Tenant Improvement Allowance
As you can see from the two sections above, reasonable really depends on what part of the country you're talking about.
The TI is offered on much older buildings most of the time, and this is a fact that tenants are going to have to keep in the back of their minds as they begin to look at what they need to do to improve the space.
The TI is supposed to allow for a real win-win situation between landlord and tenant. The tenant is setting some money to cover the renovations needed, and the landlord is getting an improved space that will hopefully be worth far more in a future lease agreement.
The tenant has to go into the deal knowing about the allowance and how to make the allowance cover what's needed and how to transform the space. It's a high level of creative control, and no two buildings will be the same for this reason.
Capturing More Momentum
The markets may determine what's reasonable and isn't, but hitting the ground running is more important than ever.
The post-pandemic's highs and lows are always shifting, but consistency is critical for tenants looking to capture new business objectives and audiences.
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