What Is The Effect of Tenant Improvement Costs on Rent?

What Is The Effect of Tenant Improvement Costs on Rent?

Tenants shopping for new space should understand how the cost of Landlord funded Tenant Improvement affects rent. When negotiating for space, one of the first questions a Tenant should ask is whether the advertised rent includes any TI allowance because after negotiating a comfortable rent, Tenants who then turn attempts to negotiate a TI allowance as an incentive to lease will find that rent will increase as TI dollars increase.  However, Tenants should be careful to assure that the increase in rent is limited to the actual cost of the TI allowance and that the Landlord is not adding a profit, unless the profit was specifically negotiated.

 

The formula for adding Landlord funded TI to rent is simple:

TI =     {(X/Initial Lease Term in Years)}

________________________                      add result to per square foot Rent

{Premises Square Feet    }

 

For example, if the Landlord has agreed to a $180,000 TI Allowance and the initial lease term is 5-years on a 4,000 square foot lease, $9.00 per square foot would be added to the quoted rent [(180,000/5)/4000].  If rent was originally quoted at $18 per square foot, with the TI added, rent would now be $27 per square foot.  Of course CAM would be a separate issue.  If the Landlord quotes rent higher than $27, Tenant should be aware that landlord is charging overhead or is not providing all of the improvements for which Tenant is being charged.  Additional negotiations might be necessary.

Another point Tenant should consider is rent increases following the initial term.  While annual increases during the initial term are, and should be adjusted, on the gross amount (including the adjustment for TI), following the initial term, rent at the commencement of the first renewal term should be adjusted back to the base rent without the amortization for TI.  Most Landlords and Tenants over look this in negotiations and negotiations begin with the same percentage increase on the rent from the end of the initial lease term.  Other times, Landlords attempt to re-set rent based on “market rent” then existing, but with a floor, limiting the ability to lower rent below the rent of the prior year or even adding a percentage above the prior lease year.  Tenants who have paid the fully amortized cost of TI should insist that, at the beginning of the first renewal term, that rent be adjusted to deduct the cost of the TI.  Increases going forward would then be based on the adjusted amount.

If Tenants are aware of how TI allowance affects rent, there should be cost savings down the road.  Be savvy!