What Are Commercial Tenant Improvements & How Do They Work?
Commercial tenant improvements, also known as commercial leasehold improvements, occur when a landlord offers payments or discounted rent to a tenant in exchange for tenant improvements to a property. Either the landlord or the tenant hires contractors to complete the work. The landlord will either pay for the repairs directly, reimburse the tenant for the repairs, or offer reduced rent for the tenant.
The four types of commercial tenant improvements that are most common are:
- Tenant improvement allowance (TIA): The landlord gives the tenant a certain amount of money to make the improvements. The tenant oversees the work.
- Rent discounts: The landlord offers the tenant free or reduced rent for a certain number of months equal to the cost of the work completed. The tenant oversees the work.
- Building standard allowance (buildout): The landlord offers a package of improvements to each tenant, and the tenants choose which improvements are made. The tenant pays for any improvements beyond the buildout. The landlord oversees the work.
- Turnkey: The tenant submits a design plan showing potential improvements and the estimated costs of the improvements. The landlord pays for the improvements and oversees the work.
Type of payment model | Who oversees the work? | Pros | Cons |
|---|---|---|---|
Tenant Improvement Allowance | Tenant (usually) | You have control and are less likely to have quality issues or cost overruns. | You need to spend time and money overseeing the work, and the work could bother other tenants. |
Rent Discounts | Tenant (usually) | You have control and are less likely to have quality issues or cost overruns. | The landlord may raise rent later to make up for the discount, and the work could bother other tenants. |
Building Standard Allowance (Buildout) | Landlord | You don’t have to spend time finding a contractor or overseeing work. | You can’t do a lot of customizations or complex work. |
Turnkey | Landlord | You can request customizations, and you don’t have to oversee the work. | The landlord’s contractor may do a poor job. |
Because you may have to pay for improvements before being reimbursed by the landlord, you might need an easy business loan to cover those expenses. Fundbox is an excellent choice for an easy business loan. As long as you’ve been in business for at least six months and have a personal credit score of 600 or higher, you can receive funding within one business day with Fundbox.
Visit Fundbox’s website for more information and be sure to check out our guide on getting a small business loan before you apply.
Pros of Commercial Tenant Improvements
Each type of commercial tenant improvement has its own “pros,” depending on who is overseeing the project, who is paying for it, and the possible side effects of renovations to your space.
With tenant improvement allowance and rent discounts, you have control of the renovation because you typically oversee the work. This limits potential cost overruns or quality issues if you aren’t managing the renovation.
With building standard allowance and turnkey, you don’t have to spend your time or money finding a contractor, buying insurance to cover workers, or overseeing the work because the landlord oversees the renovation. In addition, with a turnkey payment model, you can request customizations instead of choosing from options selected by your landlord
Cons of Commercial Tenant Improvements
As with the “pros,” the “cons” for each type of commercial leasehold improvement vary between payment types.
Tenant improvement allowance and rent discounts can cause renovations that might disturb other tenants in the building, or worse, affect the structural integrity of the building. You also have to spend time and money finding a contractor in both cases. With rent discounts, your landlord might decide to raise your rent later to make up for the temporary discount.
With a buildout, you can’t do many customizations. In most cases, you have to choose options provided by your landlord. If you want customization to those options, you usually have to pay for it yourself. And with a turnkey payment model, the landlord’s contractor might do a poor job attempting to complete the customizations you have chosen.
How to Negotiate Improvement With Your Landlord
The portion of your lease covering improvements, usually called the “improvements and alterations clause,” is something you can negotiate with your landlord. When negotiating commercial tenant improvements, here are some things to consider:
How Much Money Is Needed?
The landlord will consider several factors before deciding how much money to allocate for improvements:
- Whether the current market favors tenants or landlords: If you have lots of options for commercial space, this could give you more leverage in negotiations.
- Length of your lease: The longer you plan to stay, the more likely the landlord will pay for improvements.
- Amount of rent you’ll be paying: The higher your rent, the more likely the landlord will pay for improvements.
- Your business history and value to the landlord: If your business has historically drawn lots of customers, the landlord will be more inclined to pay for repairs.
- Location of the company: If the commercial rental market is competitive, that gives you the upper hand in negotiations.
Who Will Do the Work?
If a tenant oversees the work, the project will usually be done correctly with limited cost overruns. The more control the tenant gives up to the landlord in commercial leasehold improvements, the more likely the tenant won’t get what they paid for, and they’ll probably spend a lot more for shoddy work.
When Will the Work Be Finished?
Delays on large projects are inevitable. Make sure these projects don’t bump up against a lease expiration. Delayed improvements can also hinder your ability to run your business at total efficiency.
What Does the Payment Cover?
Landlords typically want tenants to use the money provided for labor, materials, and construction. However, there are additional costs, including design consultation fees, legal fees, and delivery costs for materials.
One other thing to consider is that improvements aren’t the same as trade fixtures. Improvements are affixed to the property and remain if the tenant leaves. Trade fixtures, such as window air conditioner units, are mobile. The tenant can remove those if they decide to go.
Tax Benefits of Commercial Tenant Improvements
Whoever does the work on a tenant improvement can depreciate them on their business taxes. If the landlord does the work, the landlord gets the depreciation. If the tenant does the work, the tenant receives the tax benefit. Of course, consult with your tax professional before taking any depreciation on commercial leasehold improvements.
Bottom Line
Commercial tenant improvements can allow you to customize your commercial space and potentially have the upgrades paid for by the landlord. They can be paid as a reimbursement, a rent reduction, or possibly as a direct payment by the landlord to a contractor of their choosing.
Understand the pros and cons of each type of commercial leasehold improvement before deciding on a specific type of improvement. Also, consult your legal advisor before entering any lease and your tax professional before taking depreciation from commercial tenant improvements.
