Negotiating a lease with a new tenant can sometimes string out for weeks or even months as the two parties try to reach an agreement about all of the terms. One of the main topics that landlords and tenants will go back and forth on is the tenant improvement allowance.
What is a tenant improvement allowance (TIA)?
The tenant improvement allowance (TIA) is the amount a landlord is willing to pay to renovate a space before a tenant occupies it. TIAs are standard in commercial office leases, and you’ll sometimes see them in retail leases, but landlords rarely offer them in industrial leases.
The amount that you should offer for TIA depends on several factors, including the length of the lease, the condition of the space prior to occupancy, and the health of the local real estate market.
Like the lease rate, the TIA is usually quoted in dollars per square feet. So if you list the rent at $17 per square foot, you might list the TIA at $20 per square foot. If the space is 5,000 square feet, then you’re saying you’ll pay up to $100,000 for renovations.
So how much is too much?
First, let’s distinguish between first-generation space and second-generation space. First-generation space is space that has not been finished with carpet and walls, like new construction or a major renovation. Typically, fitting up a space for the first tenant will cost more than for all future leases.
If you’re dealing with a second-generation space, a simple rule of thumb is to calculate the payback period, meaning how long before the lease payments equal your up-front renovation costs. If that’s longer than half of the lease, that’s probably too much.
If the market is healthy and your building is in good condition, you should avoid offering a TIA with a payback period of more than two or three years on a 5-year lease. The TIA is just one of many factors that can eat into your profitability.
But, there are some situations where you might need to consider a longer payback period. For example, if the tenant signs 10-year lease, then a three or four-year payback period is reasonable. And if your market is in a recession, or if your space has been vacant for more than five years and needs significant updates, then it could be worth it to offer a larger TIA and hope that the tenant will renew their lease after the first term. But that’s a risky move, because the tenant might not renew, and then the next tenant is likely still going to want their own customizations.
At Culmen Real Estate Services, we deal with TIAs every day. We have decades of experience negotiating with tenants and finding solutions that factor in all of the issues we’ve just mentioned.
Talk to one of Culmen’s experienced consultants to help avoid the many pitfalls of TIAs and get the most out of your investment.