Flexible and remote work options are a new frontier for commercial real estate (CRE) landlords. CRE investments are increasingly subject to tenants’ demands. Global shifts in working pose Tenant Improvements (TI) challenges on at least two fronts: understanding TI and how to account for improvements.
Tenant Improvements (TI) in commercial real estate increasingly veer toward global flexible and hybrid workplace trends. CRE landlords are pushed to retain their tenant base and adapt. TI features at the top and needs to be negotiated and agreed on upfront between CRE landlords and tenants.
TI needs for Gen Z – and others – are more than cosmetic repairs like repainting walls, refitting carpets, or redoing the lighting. CRE landlords increasingly face bigger tenant demands, and landlords need to know the gameplay to stay relevant in new leasing markets. CRE landlords’ responsibilities and how to account for TI include tapping into Tenant Improvement Allowances.
CRE Landlords Must Critically Consider Tenant Improvements
With over half of America’s workforce going full-out for flexible work, many commercial real estate landlords are affected. CRE landlords are now thinking of new ways to keep their tenants and attract new ones.
The demands on CRE landlords come with huge TI costs associated with flexible and hybrid office arrangements. Leveraging a Tenant Improvement Allowance favors CRE landlords and gets tenants what they want.
What is Tenant Improvement Allowance (TIA) in CRE?
Commercial Real Estate (CRE) landlords can benefit from Tenants’ improvement allowance or TIA. TIA is a federal association loan with economic spin-offs to assist small businesses and entrepreneurial developments. As much as CRE landlords gain from TIA, so does the economy.
The trade-offs for CRE on improvements on leased space are directly linked to TIA. TIA is a means to spruce up leased property. It makes buildings valuable and appealing to tenants before they move in and is part of the lease.
TIA is used to make leasehold improvements that meet tenants’ operational needs and preferences. It also pays fees for:
- Architects
- Engineers
- Planning consultants
- Construction costs
TIA And CRE Landlords’ Gains
CRE landlords need to know they can add long-term value to their property through a tenant improvement allowance that’s part of a lease agreement. TIA is included in the initial lease agreement to ensure that the base rent remains as stipulated. If added afterward, the primary rental will have to be renegotiated.
CRE landlords benefit from TIA as they do not have to oversee the projects. A turn-key project team can work with the tenants leading the project. Also, landlords are not liable to fund costs or costs that exceed the allowance. CRE landlords thus benefit from the improvements, and the onus is on tenants to stick to the budget.
CRE landlords Must Account For Tenant Improvements
Tenant improvements or TI on a leased business space are the responsibilities of the CRE landlords. CRE landlords and tenants agree on these in a lease to avoid disputes. The cost and who bears responsibility for the work is negotiated between the tenant and the landlord.
Commonly, CRE landlords calculate the costs for TI improvements as a ‘per square foot’ or ‘a total dollar sum’ calculation. This is put into the lease and the contractual obligations safeguard CRE landlords.
What Landlords Must Budget For
CRE savviness rests on knowing what risks to take. TI and Tenant Improvement Allowance (part of TI) are at the core of CRE landlords’ and tenants’ agreements. These agreements are negotiated upfront. CRE landlords don’t have to offer a TI allowance when the commercial real estate market is good. TIA is mainly used as an enticement in a weaker market.
These also have tax implications for CRE landlords and tenants depending on who is paying for these and who owns the improvements. Generally, whoever pays for and owns the property can get tax relief through the depreciation of these improvements.
TIA is also thought of in other terms. TIA is a fixed amount, and if the expenses go over and are under the amount, this can mean a higher or reduced rental. TIA can be exchanged, for example, for three months of free rent or an amount calculated per square foot of the size of the total space and deducted from the rent.
Whatever the decision about TIA is, this is part of the lease contract, and TIA (whether over or under the amount) can be calculated and written into a commercial real estate lease as follows:
total cost > TI allowance = the tenant pays the excess
or
total cost < TI allowance = the tenants’ TI is adjusted downwards
CRE landlords and tenants need to know what’s allowed for TI and how to best use TIA. A clear understanding, too, is that recarpeting, painting, lighting, and approved construction are included, but not new office furniture, computers, laptops, or high-speed internet. What’s allowed for TIA needs to be agreed on in the lease.
Accounting for Leasehold Improvements
In all scenarios, an agreement between CRE landlords and tenants for leasehold improvements has to be budgeted for. With TIA, the landlord handles the money for the improvements, and the tenant oversees the work. The TIA amount received varies and is often calculated on square footage. CRE landlords and tenants can also agree on these.
TIA is a core part of CRE leases and the tax on TI (as an umbrella for TIA) depends on who pays for and owns the improvements. Generally, whoever finances and owns the improvements claims depreciation of these improvements on their tax returns.
Knowing about TIA puts CRE landlords on a sound footing in a competitive commercial real estate market. The rise of flexible and hybrid work, however, brings challenges. It’s essential to keep to a budget and not to overspend or make improvements that are not wasted expenditures.
New Players Affect CRE Decisions
New players affect CRE portfolios with new working norms and demands for improvements. The current statistics for America:
- 58% of people working choose to do so from home at least one day a week.
- 35% of full-time people want a 5-day-a-week work-from-home deal.
- 23% of people work part-time from home.
What stands out is that people wish to have flexible work-from-home choices.
These choices increasingly affect CRE landlords, who need to maintain their CRE tenant base as millions of workers want to avoid commuting to traditional offices. With such trends, it’s no wonder that CRE landlords have sleepless nights over the challenges in commercial real estate. CRE landlords globally deal with workplace strategists and designers to meet TI needs.
From futuristic designs to workplaces as destinations of choice, CRE landlords must know what’s good to improve leased space, even if these are elaborate and costly. New standards in office planning and layout, like decentralized open-plan models rather than individual private spaces, are expensive, and TI has to be agreed on upfront.
Common Mistakes CRE Landlords Make
Spending too much on improvements is often a mistake that both CRE landlords and tenants must be aware of. CRE landlords also have to be mindful of what tenants can do, and this is usually calculated on their credit history, the length of the lease, the rental rate, and also what the real estate market is like.
Conclusion
With shifts in the workplace environment, there are new demands on CRE landlords to consider TI needs and keep up-to-date with what’s possible with TIA. TIA helps CRE landlords stay relevant and protect their commercial assets.
Using TIA to finance tenant improvements is a means to secure commercial real estate investments. In addition, CRE landlords must check spending and secure all expenditures, especially TIA, in a lease agreement with tenants.