The Tenant Improvement Allowance

Commercially rented space may have to be customized to fit a tenant's needs. You and the landlord will have to reach an agreement about who does the design, who does the work, when it gets done, and who pays for it. The lease clause that addresses these issues will be titled "Improvements and Alterations."

The most common way for landlords and tenants to allocate the expense of improving commercial space is for the landlord to give you what's known as a tenant improvement allowance, or "TIA" or "TA" for short. The TIA represents the amount of money that the landlord is willing to spend on your improvements. It's stated either as a per-foot amount or a total dollar sum. Generally, if the improvements cost more than the agreed-upon sum, you pay the extra.

Actually, you usually don't receive the TIA directly. Instead, the landlord pays the contractors and suppliers up to the TIA limit—after that, you pay. Or, the landlord may decide to give you a month or two of "free" rent, which means that you must accomplish all that you want to do with the money you've "saved" by not having to pay the rent. If you have a choice, press for the former arrangement. If the landlord gives you the TIA allowance and you pay the bills, you run the risk that the IRS will consider that income, and tax you accordingly. When the landlord physically keeps the money and pays the bills, you may avoid this outcome.

The Size of Your TIA

You'll be in a good position to bargain for an adequate TIA if you already know what your improvements are likely to cost. You'll need to rely on your space planners or designers for their advice. If the landlord is not willing to give you a TIA that will meet the budget, you may still decide that it's worth your while to fork over some of your own money in order to get the look and configuration you want.

Because you will be responsible for any expenses above the TIA, you will assume the risk (and expense) of construction overruns. The risk will increase if the landlord, rather than you and your contractor, does the construction. After all, the landlord has little incentive to keep costs within the TIA amount, because the landlord won't pay for any excess. For this reason, it may be preferable for you to suggest another way to handle improvements, explained in Alternatives to a Tenant Improvement Allowance

Protecting Your TIA

One way to control the eventual cost of your improvements is to insist in the lease clause that if the landlord will do the work, the landlord will put the job out to competitive bid, requesting sealed bids that will be opened in your presence. That way, the chances that the landlord will choose a needlessly expensive contractor—or one with whom he has a cozy relationship—are lessened.

Besides controlling construction overruns, you'll want to be on the lookout for fees that come out of your TIA. Landlords typically charge overhead and "administrative" fees for tenant improvement work, even if the landlord does not take charge of the work. These fees (which may also be charged by the landlord's contractor, if he is involved) will come out of your TIA, which the landlord is simply using as a profit source. The more your TIA is depleted by fees, the less you have to spend on the actual work. During lease negotiations, make sure you find out what these fees are going to be and whether they are in keeping with the leasing practice in your area. Check with your broker or other knowledgeable business tenants.

Learn how to Get a Good Expansion Rights Clause in Your Lease.

Using Your TIA

Don't let your landlord tell you that your TIA is a concession or a gift. If the work you're doing constitutes capital improvements (improving the building in a way that will benefit any future tenant), the work may be something that by rights the landlord ought to pay for. But even if the work is truly specific, in response to your tastes or unusual business requirements, and the landlord has nevertheless ponied up some cash, don't be fooled—you can be sure that landlords peg their rent demands high enough to compensate them at least in part for the TIA they're paying you.

Once you understand that the TIA is rightfully yours (you've paid for it, one way or the other), you'll want to have some leeway when it comes to spending it. Consider bargaining for the following two agreements in the improvements clause:

You may use the TIA for a wide range of expenses. Especially if the landlord has secured the right to keep any unused TIA, be sure that you have broad discretion as to how you will spend it. For example, you should be able to apply your TIA to architects' and attorney fees, permit charges, moving costs, and even your own time spent securing zoning variances or permits.

If you don't use the entire TIA, you will get a set-off against rent. In the unlikely event that the final costs are less than the TIA, the balance should be credited against your rent. Returning it to the landlord in essence deprives you of the benefit of all your hard bargaining over who pays for improvements.

Learn more about Tenant Improvement Allowances.