One of the most important issues in a lease negotiation is the financing of tenant improvements by the landlord.  Tenant improvement financing is usually provided in one of two ways.

Tenant Improvement Allowance

Under the “tenant improvement allowance” approach, the tenant negotiates a cash allowance to be used for construction and related costs.  The tenant is responsible for costs that exceed the allowance.  If the allowance is properly negotiated, the tenant retains the savings if construction costs are less than the tenant improvement allowance.  Construction may be managed by the tenant or the landlord.  Since the tenant is financially responsible, the tenant should manage construction under the tenant improvement allowance approach.

Turnkey Buildout

The second approach to tenant improvement construction financing is a “turnkey buildout.”  In this approach, the landlord, at its sole cost, is responsible for all elements of construction.  With a turnkey buildout, the landlord manages the process and bears the financial risk of construction costs going over budget.

In this blog post, we will explore the pros and cons of tenant improvement (TI) allowance provisions.  Pros and cons of the turnkey buildout approach will be discussed in a separate post.

Pros of a Tenant Improvement Allowance Approach

• Tenant retains control over the process and budget, and is in the best position to ensure work quality;
• Tenant may have specialized construction needs that the landlord’s team isn’t able to handle appropriately;
• Tenants with more than one location may be able to leverage national pricing agreements;
• If the provision in the lease was property negotiated, the tenant will keep any overage.

Cons of a Tenant Improvement Allowance approach

• Tenant is responsible for costs that go over the budgeted amount;
• Tenant is responsible for negotiating with contractors and government agencies, and may have less negotiating power, leverage and buying power than a landlord has;
• Tenant may be liable for costs associated with “base building” deficiencies, including issues that may complicate permits;
• Tenant may have more upfront capital outlays;
• A fixed lease start date may mean that the tenant is responsible even before construction is finalized due to unforeseen delays.

There are a number of potential pitfalls tenants should be aware of prior to signing a lease with a tenant improvement allowance provision.  Tenants should remember that, even if they are managing construction, the landlord will require approval of vendors (contractors, architects, engineers).  Negotiate the approval of important vendors in the lease, before construction starts.  Most importantly, engage a tenant representation broker along with qualified project managers and architects as needed to conduct due diligence and identify any potential issues that should be addressed and planned for during lease negotiations.  Read more about how to negotiate leasehold improvements.

At Golden Group Real Estate, we specialize in tenant representation real estate services for office space users in the Chicago area, helping local business owners find office space and negotiate lease and purchase agreements. We never represent landlords, so we are prepared to negotiate aggressively on behalf of our tenant clients.

For more on Golden Group Real Estate, read about our real estate services. Let us know if we can help you find office space for rent or buildings for sale. Call us at (630) 805-2463, email us at troy@goldengroupcre.com, or enter your office space search criteria below.