What if someone gave you $50 per square foot to remodel your home?

Would you redo your kitchen?  What about your bathrooms?  Add on a sundeck or a swimming pool?  And why would someone just give you that kind of cash, never expecting to see it again?

In the world of residential real estate, this concept may sound kind of crazy, but in the world of office leases, tenants are routinely given hundreds of thousands or sometimes even millions of dollars to build out the interior of their office space prior to starting a new lease.  Known in the industry as a tenant improvement allowance, or “TI” for short, this seemingly large dollar amount goes faster than you may think, even if you have been through the process before.

What kind of build-outs are there?

There are two types of build-out in the office leasing market.  One type is turnkey build-out and the other is a tenant improvement allowance.

Turnkey build-out is a fairly straightforward process in the eyes of the tenant.  As the tenant, you provide to the landlord, either directly or through a space planner, your proposal of what you want done to the space you will lease.  Typically done during the lease negotiation stage, this plan will include where you want walls, light fixtures, electrical outlets and phone jacks, closets and anything else that will be built into the interior.  You’ll also have the privilege of choosing paint and carpet, which are usually replaced with every new tenant to a space.  Once the plan is finalized and the lease is signed, the landlord will hire the demolition and construction crews necessary to prepare your space.  At the time of the occupancy date in your lease, all construction is expected to be complete and the landlord will deliver to you the space as you designed it, hence “turnkey”.  Turnkey build-outs are more common with smaller spaces (usually fewer than 10,000 SF) and shorter lease terms (often fewer than 5 years).

The tenant improvement allowance places the burden of construction on the tenant.  Unlike the turnkey build-out, the tenant is fully responsible for the design, hiring and oversight of the construction.  Based on the terms of the lease, the landlord may provide a drawable balance based on a $/SF ratio; the longer the lease term, the greater the number of dollars per foot.  In the Chicago market, some buildings offer as few as $25/SF and some offer as much as $65/SF or more!  This may sound like a lot of money and with a large area, it is – however, the tenant has to be keenly aware of the responsibilities and costs associated with an office build-out.  If managed poorly, even $65/ft may not come close to covering your build-out requirements.

Occasionally, you may come across a third type of build-out option.  Known as “turn-key with an allowance”, this is in fact, as you may observe, an oxymoron.  Turn-key technically means that everything will be completed and delivered to you.  An allowance, on the other hand, implies that you are responsible for the build-out.  Turn-key with an allowance is really a landlord’s way of saying, “I’d like to help you build out to your needs, but I really don’t want to spend a whole lot of money, so there’s a cap.  Beyond that cap, you can spend as *much* as you want, but don’t come crying to me when you find my allowance doesn’t cover your needs.”  Now, they won’t say it in so many words, but keep an eye out for this.  If you don’t have a tenant representative protecting your interests, at least make sure that you either negotiate for a turnkey build-out or have a strong sense of what your build-out will cost you.

Despite which approach is used, there are some commonalities to build-outs.

  • The dollars spent on your build-out are yours.  This may sound strange, since they are coming from the landlord, but who’s paying the rent?
  • If you ever terminate your lease early, the landlord will typically expect immediate reimbusement for the unamortized portion of build-out dollars spent on your behalf.  Depending on when and how you terminate your lease, this figure can run from quite small to astronomical.  Always be aware of hidden costs that may come back to get you.

If I get an allowance, what should I know in advance?

When you were a kid, if you were lucky enough to get an allowance from your folks, did you immediately run to the store or did you put it in a piggy bank until you had some time to reflect on how to spend it?  If you were the former, good luck to you.  However, for the fiscally conservative, an allowance gives you a lot of options.

  1. First of all, you need to determine if the amount will cover the cost of your build-out.  Take some time to meet with general contractors or, if you are more adventurous, be your own GC and put out bids to subcontractors for any demolition, drywall, electrical work, data wiring, lighting, carpentry, etc.  If you know the world of construction, cutting out the general contractor may save you some bucks, but I don’t generally recommend it.  Instead, save yourself some headaches and hire a project services director to oversee the project.  Your tenant representative should be able to set you up with a colleague to oversee build-out at no additional charge to you.
  2. If you are still in the negotiating phase with your (future) landlord, the second step is to adjust the TI allowance based on your expected costs.  NOTE: This should only be done if your costs are greater than the TI allowance, but you knew that.
  3. As you are completing these negotiations, it’s also worthwhile to lay out in writing exactly what the TI dollars can cover.  Some landlords only allow tenants to spend the dollars to prepare the space for occupancy; others may allow you to maintain a balance and spend it down on renovations and repairs over the course of your lease.  Occasionally, a landlord may even entertain spending some of the funds for other occupancy expenses, like furniture and interior design elements.  It’s worth asking to see where you can secure additional value from these dollars.
  4. Oversee the build-out to completion OR allow your project services director to oversee the build-out and keep you informed on the progress.
  5. Move in to your newly built-out, freshly painted space with brand new carpeting and a genuine feeling of satisfaction… as long as everything went smoothly.

What to do if things don’t go smoothly

For now, I’m going to give your landlord, your general contractor and your subcontractors the benefit of the doubt.  However, if I hear about some bad experiences that readers have had going through either build-out process, I’d be happy to share them along with advice on how to prevent or survive build-out nightmares.

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2 Responses

  1. I am looking to lease a restaurant that will need some construction to meet my needs but will not as much as the $10 per square foot TI allowance they have indicated they are willing to give. I realize they are willing to give TI because the equity will generally stay with the building but have you ever heard of them giving the extra as basically a loan to start the business?

    • Gary, I don’t have much experience with retail spaces. If the landlord is requiring you to take $10psf TI and is essentially cutting you a check and rolling it into the lease, that does sound a bit odd. However, restaurants are extremely high risk ventures, so perhaps the landlord is just looking out to increase the likelihood of your success. If I were in your shoes and I didn’t need the TI for build-out or other start-up expenses, I would request a reduced TI in exchange for a lower rental rate, if that option is on the table.

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