Tenant Improvement Allowances

January 24, 2018 | By Charles Botensten

Q. I am a real estate agent and I am beginning work on a transaction where the landlord will be giving the tenant certain allowances for improvements to the rented premises (“Tenant Improvement Allowances” or “T/I Allowance”).  What are the most important issues to be aware of regarding Tenant Improvement Allowances if I am negotiating on behalf of a landlord or tenant?

A. There are a number of issues that you should be aware of when working on a transaction that contains a T/I Allowance.  These issues will be negotiated by the tenant and landlord prior to entering into a lease.  A major issue will be whether the landlord or the tenant’s contractor will be doing the work.  Once it is determined who will be doing the work, the following terms will also have to be addressed:

1. Deposit to the Tenant’s Contractor and Timing of Disbursements of the T/I Allowance

Most tenants would prefer that the landlord fund the initial deposit required by the tenant’s contractor (usually 10% to 20% of the project budget). Most landlords would prefer to reimburse the tenant after the tenant pays the deposit to the contractor.

Similarly, most tenants prefer that a significant portion of the T/I Allowance be paid up front or paid directly to its contractor, whereas most landlords prefer that the tenant seek reimbursement from the landlord after the tenant pays for a portion of or the entire completed project.

2. Hard Costs vs. Soft Costs

Landlords generally prefer that all of the T/I Allowance be used for hard costs (e.g., labor, materials, leasehold improvements) whereas most tenants would like a small percentage (e.g., 10-15%) to be used for soft costs (e.g., architectural, design and legal fees, permits, furniture and phone systems)

3. Tenant’s Request for a T/I Disbursement

In order to receive a portion of the T/I Allowance, the tenants must deliver to the landlord a disbursement request (e.g., a written request for a portion of the T/I Allowance signed by an officer along with a partial or full lien waiver and an architect’s sign-off on the work performed).  The landlord will require that the request be detailed and complete.

4. What if the Construction Costs Exceed the T/I Allowance When the Landlord is Performing the Construction?

Landlords should attempt to ask for 100% of the shortfall (the cost of the construction exceeds the amount of the T/I Allowance) from the tenant prior to the landlord commencing the work. Most tenants prefer to tender the shortfall when at least 50% of the project is completed by the landlord.

5. Landlord Financing of the Shortfall

In the event of a shortfall referred to above, tenants may request that the landlord amortize the shortfall amount financed on a monthly basis over the term of the lease at a 5% to 8% interest rate.  If agreeable to a landlord, the financed shortfall should (a) be paid by the tenant as additional rent and (b) be personally guaranteed by the tenant’s principals.

To watch “Larry Haber and AGMB’s Sweet 16 Video Series” on Tenant Work Clauses, Landlord Work Letters and AIA Architectural and Construction Contracts, log on to http://agmblaw.com/media/larryhaber/

The Legal Line Question by:

Neil B. Garfinkel
REBNY Broker Counsel

Partner-in-charge of real estate and banking practices at Abrams Garfinkel Margolis Bergson, LLP