Most commercial spaces require some level of customization to meet the requirements for a tenant’s intended use. This can range from a complete gut and rebuild to minor aesthetic changes. Depending on a number of factors, Tenants may be required to pay for any work to the leased premises at their sole cost and expense. In many cases though landlords are willing to provide allowance that cover a portion or all of the associated costs. These allowances can take the form of either a tenant improvement allowance or a cash allowance.
What’s the difference?
A tenant improvement allowance is most often provided as a reimbursement. Tenants must pay for the cost of all work and construction materials with their own money and submit invoices to the landlord; showing that the work has been completed. The TI allowance can be structured so that reimbursements occur periodically as the work progresses or as a lump sum payment once construction is complete.
The disadvantage to this type of allowance is that tenants may need to expend significant capital to pay for the costs of the build out, which can include building permits, design fees, mechanical drawings, electrical drawings, professional fees, space planning fees, construction materials and labor, etc. Construction projects can last for many months from beginning to end, which can result in liquidity issues for tenants that are not adequately capitalized. Lines of credit are often used as a source of capital and tenants should consult with their bank negotiating the terms of a tenant improvement allowance.
If cash flow is an issue, tenants can try to negotiate a cash allowance. Similar to a tenant improvement allowance, the landlord agrees to provide a certain dollar amount per rentable square foot towards build out costs; however, in this scenario the landlord provides the funds up front, in cash. Because they are now the ones coming out of pocket, Landlords incur greater risk and will thus require a higher degree of financial stability from a tenant before agreeing to a cash allowance as well as requiring detailed provisions governing the use of the funds.
The only disadvantage of cash allowances is that they may not be an option for many tenants. In a catch-22 type situation, the tenants that need the cash allowance due to liquidity concerns may, as a result, not exhibit the financial strength to justify the landlord’s risk. For businesses that do not have the same issues, cash allowances can be a great opportunity to free up capital for other purposes.