Landlord might contribute to Tenant’s construction costs in the commercial real estate lease!
It’s important to understand the conditions to recover the tenant allowance as stated in the commercial real estate lease.
What is a Tenant Allowance?
Tenant Allowance, or Tenant Improvement Allowance, means Landlord will contribute money to the cost of Tenant’s leasehold improvements, often referred to as “work.” Tenant is usually responsible for the work itself, and Landlord will reimburse a portion of Tenant’s costs, if certain conditions are met. The scope of the work and the conditions for reimbursement should be part of the commercial real estate lease.
There are usually conditions Tenant has to meet before receiving the Tenant Allowance reimbursement. Common conditions are:
- Tenant has to pay its contractors first and get a lien release and receipts
- Tenant has to submit all of its proof of payments
- Tenant can’t be in default under the lease
- Landlord approves the scope of work, the contractors, and the insurance
Negotiation tip: watch out for unreasonable conditions, like a time limit on when the Tenant Allowance can be recovered, or unreasonable criteria for Landlord approvals.
What a Tenant Allowance is Not
It’s important to read the commercial real estate lease to understand the restrictions on the Tenant Allowance. Sometimes, it is a stated amount, or it can be an amount per square foot of the lease space. Any amounts spent over and above the Tenant Allowance are Tenant’s responsibility- estimates from a general contractor are important!
A Tenant Allowance is not a cash advance or an interest-free loan, and if the actual costs of construction are lower than the Tenant Allowance, then the Tenant will probably only receive reimbursement for the lesser amount. The Landlord have factored in the cost of the Tenant Allowance during the term of the commercial real estate lease, so consider that when negotiating the rent amount. The Tenant Allowance could be an actual reimbursement or a rent credit.
Tenant Allowance Limits
Landlord will often limit what work can be reimbursed with the Tenant Allowance within the commercial real estate lease. Negotiation tip: If Landlord is also the contractor, watch out for a management fee or supervisory fee in addition to the construction fees. Sometimes only “hard costs” are included in the Tenant Allowance, so the following expenses could be excluded from reimbursement:
- permits
- cabling and wiring
- mechanical or drawings
- space plan
- interior design
- landlord supervision
- construction management
- waste disposal fees
Is the Tenant Allowance a Good Deal?
It depends! Tenant should ALWAYS get at least one bid, and preferably 3, on any sort of construction. Negotiation tip: do not rely on Landlord’s estimate or a verbal estimate. Actual costs tend to be higher than the original bid.
If Landlord is also the contractor, make sure that the commercial real estate lease is very specific about what work is being done, and the quality, as well. Tenant should get final approval of any work that Landlord has done, and other than minor punchlist items, Tenant shouldn’t have to accept possession until all of Landlord’s work is completed correctly.