What does it take for a new commercial building to become a home to a business or to transform a previously occupied space for the new occupant? Tenant Improvements.
The “Spec” Building
When you build a new commercial building without a known tenant – a speculative building or “spec” building – the building is designed and built to “shell condition”. The building shell includes the exterior walls, windows and roof of the building.
On the inside the shell building includes base systems like mechanical (air conditioning and heat), electrical, and plumbing. Interior finishes are typically limited to the building common areas like lobby, hallways, and shared bathrooms.
You build a spec building to shell condition and stop for a few reasons including flexibility, customization, and cost.
First, if you wait to finish the building until you have a tenant you allow for the maximum amount of flexibility in the layout of the floors and spaces. You may sign several small leases in the building, a large lease for the entire building, or a combination of lease sizes.
Second, many commercial tenants want the option to customize the layout of their space. If the interior walls and finishes are already built, the tenant either has less ability to customize or you will have to do expensive rework to change the space.
Lastly, there is the cost aspect. Not only do you pay the direct construction costs of finishing the space, but the more money you spend from your construction loan, the more interest you have to pay every month.
Tenant Improvement Allowance
Once a lease is signed for a space, you will design and construct the interior finishes and systems of the tenant suite. These finishes and systems are all part of tenant specific improvements called “Tenant Improvements” or “TI” for short. The money contributed by the developer for these improvements is the “Tenant Improvement Allowance” or “TIA”. The TIA is negotiated as part of the lease negotiations.
Any cost to complete the space that is greater than the TIA is paid by the tenant.
Tenant Improvements
Typical tenant improvements in a commercial space include the interior walls, ceilings, light fixtures, floor coverings, wall paint, and built-in cabinetry for the tenant space.
If a tenant is moving into a space that has been previously occupied – a “Second Generation” space – then the Tenant Improvements are typically limited to fresh carpet and paint and taking down or building new walls. Most of the Tenant Improvements are already completed in a second generation space which makes the move in cost lower to a tenant.
A lease will often clarify the allowed uses for TI dollars. A landlord is often far more willing to invest in improvements that stay with the building than invest in valuable assets that move with the tenant. Fixtures are items that stay in the space and equipment are items that can move with the tenant.
Fixtures vs Equipment
Obviously the walls and floor tiles stay with the building. As a general rule a fixture is anything that is “affixed” to the space.
A built-in light fixture in the ceiling is a fixture while a plug in floor lamp is a piece of equipment. In a restaurant a built-in booth is a fixture while a stand mixer in the kitchen is a piece of equipment.
In an office the cubicles and desks and chairs are all considered furniture and are equipment which is typically not covered with TIA dollars.
Fixtures often are valuable to landlords and second generation tenants while a tenant-specific piece of equipment is not.
Budgets
The TIA budget for a space varies depending on the original condition of a space as well as the tenant’s use. TIA budgets are typically discussed in a dollar per square foot framework.
For example, a warehouse with a small amount of office space and a large amount of bulk storage space will have very little improvements to make. The TIA Budget for a warehouse may be $5 to $10 per square foot, even in shell condition space.
On the other end of a spectrum a lab space or restaurant, could have a much higher TIA ranging from $100 to $150 per square foot or more! A typical office space is somewhere in the middle ranging from $40 to $75 per square foot for shell space.
As mentioned above, if the TIA budget doesn’t cover all of the cost of the improvements to the tenant, the tenant will either need to pay out of pocket or negotiate additional TI dollars as part of their lease negotiation.
Additional TI Dollars
Depending on market conditions and how much a landlord wants the tenant to move in, a tenant can negotiate for additional TI dollars. Additional TIA usually takes the form of a short term loan from the landlord where the rent on the space is increased to pay back the extra upfront cost of the TIA.
Conclusion
The TIA is only one part of the lease negotiation and for large tenants could add up to hundreds of thousand or even millions of dollars. If you are looking for new space for your business I highly recommend you talk to your broker early about your own budget and ask them for their sense of the market for how much TIA landlords are offering for shell and second generation space. The TI process can have a big impact on rent and move-in cost and timing.
