Commercial Leasehold Improvements: Payments, Financing, and More

Landlords often offer payment or a discount on rent so that tenants can make necessary commercial leasehold improvements. Rented commercial property may need some work before it’s suitable for your small business. For example, an office business may need cubicles for employees, and a restaurant may need a new kitchen. These are called commercial leasehold improvements.

With commercial leasehold improvements, tenants sometimes have to cover the upfront cost of improvements. If you need money to fund these expenses fast, a short term business loan can get you funded in as little as 24 hours. Short term lenders have easy online application process with higher approval rates. Check out our review of rates, terms, and qualifications in our complete review.

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How Commercial Leasehold Improvements Work

A commercial leasehold improvement refers to modifications or additions to commercial space to make it suitable for your business needs. This can include electrical and lighting modifications, breaking down a wall, adding an additional room, etc.

There are four main ways in which a landlord will pay for commercial leasehold improvements:

1. Tenant Improvement Allowance (TIA) – In most cases, the landlord will give you a certain amount of money known as a tenant improvement allowance to make improvements. The tenant usually oversees the work. The amount you’ll receive varies based on several factors, but an average TIA is about $5 to $15 per square foot.
2. Rent Discounts – The landlord will offer free rent or a discount on rent for a certain number of months. You can use the savings to pay for improvements. The tenant usually oversees the work. Again, the size of the discount varies, but one popular option is one month of free rent for every one year on the lease. For example, if you sign a three year lease, you might get three months of free rent.
3. Building Standard Allowance (aka “Build Out”) – The landlord will offer a package of improvements for every tenant, and you can make selections from the categories offered (e.g. choose one of three types of available flooring). You must pay for improvements not included in the standard build out. The landlord oversees the work.
4. Turn Key – You submit a design plan showing the improvements you want and cost estimates. The landlord pays for and oversees all the work.

Summary of Commercial Leasehold Improvement Payments

Now, we’ll discuss the pros and cons of each of these options in more detail.

What’s the Best Way to Get Paid for Improvements?

How landlords offer to pay for improvements will depend on a number of factors:

• The location, type, and age of the property
• The number of potential tenants who are interested in the property
• What has worked well for the landlord and tenants in the past

Tenant Improvement Allowance – Pros and Cons In Detail

The most common way that landlords pay for commercial leasehold improvements is with a Tenant Improvement Allowance (TIA). A TIA is a certain amount of money (a fixed amount or an amount per square foot) that the landlord gives you to make improvements. If the cost of improvements exceeds the TIA, you pay the extra.

The advantage of a TIA is that, in most cases, you retain control over the renovation process. You choose a crew that will complete the improvements, and you choose the materials. If you’re in charge, you don’t have to worry about the landlord cutting corners.

On the downside, getting a TIA means you have to put in the time to find skilled contractors. If the contractors are slow to get things done or charge more than they estimated, that will be on your dime.

Your contractors will need to carry worker’s compensation insurance and a bond in case the money runs out before the work is finished. In addition, you need to take the time to become familiar with your lease and the building. If your crew makes a renovation, for instance, that screws up plumbing for all the tenants in the building, your landlord isn’t going to be happy and may charge you for repairs.

Rental Discounts – Pros and Cons In Detail

A rental discount is similar to a tenant improvement allowance because you get a fixed amount of money to make improvements, and you’re in charge of the improvements. The difference is that, instead of getting a fixed amount upfront, you get a savings on rent. For instance, the landlord may offer “two months free rent.” With the savings, you can make necessary improvements.

This has the same pros and cons of the tenant improvement allowance. While you get more control over making the modifications, you have to pay for cost overruns and avoid any renovations that could damage the property’s structural integrity. In addition, to make up for the rent discount, a landlord may raise the rent later on, so be sure to compare the rent against the rent for equivalent properties in the area.

Building Standard Allowance – Pros and Cons In Detail

With Building Standard Allowances (BSAs) or “build outs,” landlords will offer an array of improvements which you can choose from. These are common in newer buildings. For example, the landlord may offer you recessed lighting, wooden flooring, or a certain paint color. If these options are agreeable to you, it’s one of the most economical ways to go. The landlord’s crew does all the work, and the landlord pays for everything.

The downside is limited choice. If you want custom modifications or have complex renovations in mind, then the landlord’s standard build out may not meet your needs. There’s also the risk that the landlord’s crew will do a shoddy job or use cheap materials. You (and your customers) may not be so happy with the result.

Turn Key – Pros and Cons In Detail

In some rare cases, the landlord may offer to pay for everything and give you a “turn key” commercial space.

This is similar to the BSA approach, but in this case, you can request custom improvements. You provide the landlord with blueprints and specifications showing the improvements you would like. The landlord then undertakes the work with his or her own crew and pays for everything.

If a turn key approach seems to good to be true, it might be because it is. The landlord may charge a higher rent than equivalent properties in exchange for doing a turn key renovation. The landlord may do a shoddy job or use cheap materials. If you go with the turn key approach, it’s helpful to have a contract clearly specifying what materials should be used, what substitutions are allowed, and what timelines will be followed to keep the work on track.

How to Negotiate With Your Landlord About Improvements

The portion of your lease that covers improvements is usually called the “Improvements & Alterations” clause. Here are some things to consider when negotiating this clause with your landlord.

How Much Money Do You Need?

TIAs typically fall in the range of $5 to $15 per square foot. If the landlord is offering rent discounts, he or she may offer 1 month free rent for every year on the lease. Ultimately, however, the landlord will consider several factors when deciding how much money to allocate for improvements, including the following:

• Does the current market favor tenants or landlords?

• Length of your lease term – The longer you’re staying, the more the landlord will be willing to spend for improvements. In general, you should stay for at least 3 years for the landlord to pay for improvements.

• Amount of rent you’ll be paying – The higher rent you pay, the higher payout you will likely get for improvements.

• Your business’ history and value to the landlord – A business that has a history of drawing a lot of customers will get more money than a brand new business.

• Location of the business – Commercial rentals are more competitive in some places than in others. For example, New York landlords are likely to offer fewer concessions than a landlord in Kentucky or Kansas.

As a tenant, you have to work within these constraints, but you can also do a few things to help yourself. The first is to come to the negotiation table with a clear idea of what improvements are needed and how much they will cost. You can consult a designer to survey the space and give estimates for necessary renovations. Without having such plans in advance, you risk agreeing to an amount of money that’s not enough to cover all the work.

If you receive a TIA, there’s a chance you may not use the entire allowance. Some deals allow the tenant to keep the unused portion of the allowance for future improvements. In other deals, the landlord is entitled to recover unused portions of the allowance. Try to negotiate for the former, so you have leeway to make improvements in the future.

Who Will Do the Work?

Unless you’re seeking really basic modifications, it is to the tenant’s benefit to try and preserve as much control over improvements as possible. With a TIA, it is usually the tenant who oversees the improvements. This will ensure that the work is done correctly, limit cost overruns, and ensure that quality materials are used. However, make sure you provide your landlord with a copy of your design plans and read through your lease to make sure your planned renovations don’t violate any agreements.

Michelle Wogan, Executive Vice President at commercial real estate firm Transwestern, says that with smaller tenants, landlords sometimes prefer to control the construction process using the building architect and a bidding process for general contractors. The tenant moves into the space once completed. If the landlord insists on having control, you should put down in writing the specifics of how the job will be completed: What materials will be used? What’s the estimated time of completion? How will the tenant be compensated for delays? Will the landlord charge fees for overseeing the renovation process? If so, how much?

When Will the Work Be Finished?

Sometimes, no matter how well planned out things are, delays occur. Wogan cautions that “permits may delay occupancy and the construction process may be slowed so tenants are advised to get some protection if they are running up against a deadline (i.e., lease expiration). The landlord may be able to provide free temporary space to a tenant if the space is not yet ready for occupancy, but this must be negotiated as part of the lease.”

Remember, the longer the improvements take, the longer it will be before you can start selling to your customers and turning a profit.

What Does the Payment Cover?

Sometimes, landlords will place restrictions on what a TIA can be used for. They will want tenants to use it only for labor, materials, and construction. However, tenants can negotiate to have auxiliary costs included, such as design consultant fees, legal fees, delivery costs for materials, and more.

Keep in mind that Improvements are different from trade fixtures and equipment. Improvements are affixed to the property, whereas “trade fixtures” are more mobile. For example, a window unit air conditioner would be a trade fixture, not an improvement. This distinction is important because (unless your lease says otherwise) the landlord legally owns improvements once they are installed and is responsible for repairing improvements should they fall into disrepair. In contrast, the tenant pays for and owns trade fixtures and may, under most circumstances, legally remove the fixtures when they relocate. Consult a landlord-tenant attorney or business attorney for further details.

Improvements also shouldn’t be confused with equipment. Equipment includes things like appliances, vehicles, and machinery that you need to do your business on a day-to-day basis. As with trade fixtures, equipment is typically the tenant/small business owner’s responsibility.

Tax Benefits of Commercial Leasehold Improvements

The party that does the work on leasehold improvements can depreciate them for a tax savings. If the landlord does the work, he or she takes the depreciation. If the tenant does the work, the tenant takes the depreciation.

According to Investopedia, the current rule is that leasehold improvements can be depreciated in a straight line over a 15 year period. For example, if you do $100,000 worth of commercial leasehold improvements, you can deduct $6,667 on your business tax return over the next 15 years. If you leave the property before 15 years, you can depreciate whatever is remaining at that time all at once.

There are several rules about depreciation and they change frequently, says Wogan, so it’s best to consult with a tax attorney or other tax professional.

Financing Options for Additional Commercial Leasehold Improvements

No matter how good a negotiator you are, your landlord may not cover all the leasehold improvements you want to do to get your commercial space ready for business.

In this case, you may need financing to complete additional work. An SBA loan or a fast working capital loan if time is of the essence can be good ways to pay for improvements.

Remember to always get written permission from your landlord before completing any improvements on your own.

Final Thoughts

A key component of any commercial lease is how improvements will be handled. The amount of money you get paid for improvements, which party does the work, and what the payout covers all have a significant impact on your happiness as a tenant and ultimately, on your success as a small business owner. Following the tips above will help you get to a mutually agreeable decision with your landlord.

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