A large element of any lease negotiation is the determination of the tenant’s construction allowance, otherwise known as the tenant improvement allowance or TIA. The amount and structure of the TIA can directly impact the rental rate of the deal.
The goal for any tenant is to negotiate the greatest amount of control and flexibility when determining and securing a tenant improvement allowance.
A landlord will typically provide a tenant improvement allowance that is structured in one of two ways:
- Turnkey: The landlord will cover 100% of the tenant improvement costs and associated fees, as a part of the negotiated rental rate.
- Allowance deal: The landlord will provide a flat dollar amount to be used by the tenant to build their space and cover any ancillary fees.
Many tenant representative brokers will stress that their client wants a “turnkey buildout”, but what they should try and do is minimalize actual out of pocket expenses and maximize the amount of the tenant allowance. Let’s explore the issue with a turnkey buildout.
When agreeing to a turnkey allowance, many landlords will actually use this as a profit center. They do this by building in a large contingency into the allowance, as much as 15-20%, thus potentially creating a profit center if they manage the construction efficiently.
Consider: The landlord budgets an allowance of $40/sf and factors their rent based on this budget. The landlord, through efficiently managing the process, is able to complete the construction for $32/sf, increasing their return on the rent deal. Thus, the tenant has surrendered $6/sf that could have been driven into building the space, or being used for free rent or some other contingency. Instead, the landlord has pocketed the money and increased the deal profit.
This is why, in many cases, it is better to negotiate a set dollar amount for the TIA, and maintain control over the process during the buildout phase.
Negotiating for a stated construction allowance means a tad more upfront work by the tenant’s broker, but the added control it provides can ultimately save money.
It is important as a part of an allowance deal to maintain the right to retain your own project manager. This manager will coordinate all construction and works solely for the tenant. Essentially, shifting control from the landlord to the tenant. This provides the ability to:
- Maintain quality control
- Allows tenant team to value engineer the plan, and competitively bid the plans to ensure the tenant realizes the maximum benefit from the construction allowance.
As a part of any allowance deal, it is a good idea to negotiate for the tenant to have the right to amortize any excess costs into the rental rate, usually at an agreed to interest rate. The tenant can also always elect to pay these overruns, upgrades, or change orders as cash to the landlord.
There are some deals where the work only involves minor construction like paint, and carpet. In these cases having a turnkey allowance is not a bad idea, since the risk is minimal of cost overruns. But, where there are any major construction to be done, it’s many times a better idea to work with the negotiated construction allowance option.