In commercial real estate, tenant renovations are super common. Every business has its own unique needs for the space it occupies, whether it’s a restaurant, office, retail shop, or medical facility. That’s where commercial tenant improvements (TI) come in. As a landlord, you must prepare to help your tenants meet their business needs. To simplify this process, I’ve compiled a guide that breaks down what commercial TIs are, the different types, the pros and cons, and the tips for negotiations. Let’s get started!
What Are Commercial Tenant Improvements (TI)?
Commercial TI, also known as commercial leasehold improvements or build-outs, are changes or repairs a landlord makes to their property as part of the lease agreement to meet a tenant’s specific needs and requirements. These renovations can range from minor cosmetic changes to significant upgrades. The primary purpose of a TI is to create a customized and functional space that is tailored to the tenant’s business needs and operations. A few examples of tenant improvement projects include the following:
- Building or removing walls
- Heating, ventilation, and air conditioning (HVAC)
- Adding doors and windows
- Interior or exterior painting
- Adding partitions or rooms (e.g., dental offices, doctor offices, or office spaces)
- Adding a drive-thru or changing the parking lot (e.g., food service)
- Changing or adding lighting
- Electrical work
- Flooring or carpeting
Important Note: Any removable items or changes that don’t provide value to the property are not considered part of TI. This would include decorations, furniture, or electronics.
How to Implement Commercial Tenant Improvements
Setting up a great workspace is key to the success of any business. Before you make any updates or changes, familiarize yourself with the process. Here are the steps to learn how to make commercial improvements when needed.
Step 1: Assess Your Needs
Before starting any improvement project, the first step is assessing the needs and restrictions, aside from taking care of normal wear and tear. Doing this helps create effective, efficient, and tailored commercial TIs that meet the business’s unique needs. Consider the following points:
Step 2: Learn the Types of Commercial TI Agreements
Commercial tenant improvements seem pretty straightforward, but there is still some confusion about how they actually work. Like any other real estate deal, landlords and tenants agree in various ways. Here are the four most common types of tenant improvement agreements:
| Tenant Improvement Allowance (TIA) | Tenant (usually) | The landlord gives the tenant a certain amount of money to make the improvements. This is the most common type of commercial improvement agreement; in these cases, the tenant oversees the work. |
| Rent Discounts | Tenant (usually) | The landlord offers the tenant free or reduced rent for a certain number of months equal to the cost of the work completed. The tenant oversees the work. |
| Building Standard Allowance (Build-out) | Landlord | The landlord offers each tenant a package of improvements, and the tenants choose which improvements are made. The tenant pays for any improvements beyond the build-out, and the landlord oversees the work. |
| Turnkey | Landlord | The tenant submits a design plan showing potential improvements and their estimated costs. The landlord pays for the improvements and oversees the work. |
Important Note: Many other details can vary within these improvement agreements. For example, the landlord may pay for the TIs directly or offer a tenant reimbursement for improvements. As a tenant, getting a business or tenant improvement loan might be the best choice if you have to pay for the renovations before getting reimbursed.
Step 3: Weigh the Pros & Cons
Consider the tax benefits when looking at the pros and cons of tenant improvement agreements. You might wonder, “Who pays for tenant improvements?” and “Who gets the tax benefit?” Whoever handles the improvements can write off the costs on their business taxes. So, if the landlord takes care of it, they get the tax breaks, and if the tenant does the work, the tenant gets those benefits. Just remember to chat with your tax advisor before claiming deductions on commercial leasehold improvements.
Each type of improvement has pros and cons, depending on who is overseeing the project, who is paying for it, and the possible side effects of renovations to your space. Check out the table below to know the pros and cons of each type of commercial tenant improvement:
| TIA | ||
| Rent Discounts | ||
| Build-out | ||
| Turnkey Property |
Step 4: Get Familiar With the Top Improvements
If you’re a commercial landlord or a tenant looking to rent a space, knowing what improvements are most in demand can really make a difference. Features like energy-efficient lighting and up-to-date security systems are huge draws. Remember these popular upgrades for your rental property to attract and retain great tenants while maximizing your investment returns.
Sustainable Solutions
Green initiatives are gaining popularity in commercial tenant improvements, with businesses seeking eco-friendly materials and energy-efficient technologies to reduce their environmental footprint. Some examples of sustainable solutions are the following:
- Using solar energy or panels as a primary source of electricity
- Installing green roofs or walls to improve insulation and air quality
- Adding large electrochromic glass windows
- Providing recycle bins
- Using low-flow plumbing fixtures to reduce water consumption
Flexible Workspaces
The demand for flexible and adaptable workspaces has increased significantly with the changing nature of work office spaces. Businesses are now looking for commercial spaces that can easily be reconfigured and scaled up or down according to their needs. This allows them to create an environment conducive to productivity and growth while saving on costs and space utilization. If you want to make your workspace more flexible, consider implementing the following design elements:
- Create call rooms to minimize disruptions to other employees.
- Install sound-absorbing products like panels or acoustic ceiling tiles to reduce noise from other areas.
- Make use of natural lighting and add shades that can filter light effectively.
- Choose furniture and storage options that are movable and adjustable to support different work arrangements.
Smart Technologies
Integrating cutting-edge smart technologies revolutionizes commercial spaces, significantly increasing efficiency and technological advancement. Think: Internet of Things (IoT) devices, automated systems, and Artificial Intelligence (AI)-powered tools. This transformation is a significant shift in how businesses operate, enabling them to streamline their processes and enhance productivity. Here are some examples of smart technologies that can make your workspace more advanced:
- Smart screens like Zoom and Microsoft Teams improve the video conferencing experience.
- Smart desks can automatically adjust height to enhance ergonomic well-being for employees.
- Occupancy sensors can detect real-time occupancy levels and automatically adjust lighting, heating, and ventilation systems.
- IoT devices include smart locks, entry control systems, and network monitoring tools.
Important Note: Trade fixtures are not the same as improvements. Improvements are more permanent renovations affixed to the property, which stay when the tenant leaves. Tenants cannot remove improvements, but they can remove trade fixtures, like window air conditioner units, furniture, and signage.
Step 5: Establish a Budget
One of the most important steps in planning for commercial TIs is setting a realistic budget that incorporates all the necessary costs. To avoid unexpected costs or delays down the road, set extra funds aside and work with contractors and designers to create a thorough plan that outlines all the expenses.
By establishing a realistic budget and clearly understanding the expenses, you’re setting yourself up to complete your tenant improvement project within your financial means and meet expectations. Some of the costs included in a budget are:
Step 6: Negotiate the Improvements
Landlords and tenants have the ability to negotiate tenant improvements since they aren’t required or restricted by law. Use the “improvements and alterations clause” section of the lease to negotiate the build-out allowance or other features of an improvement. Here are some things to keep in mind when negotiating:
Pro Tip: It’s better to negotiate before the renovations begin to set everyone up for success. However, if the tenant improvements exceed the allowances, negotiating to increase the amount or adjust the rent price will be necessary.
Step 7: Hire an Architect & Contractor
If you’re renovating a commercial space, hire a commercial tenant improvement contractor and an architect to oversee the design and construction to meet the needs of the business and comply with local regulations. These experts manage all aspects of your tenant improvement project, from its initial architectural planning to the final touches of the building process, ensuring that everything is completed to the highest possible standards. While both will be able to guide with building codes, permits, and structure modifications, here are the key differences between the two:
- Architects: They are experts in design and create functional, secure, and visually appealing spaces. They play a key role in bringing a vision to life and an atmosphere that reflects a brand and supports business operations.
- Contractors: They are experts in infrastructure upgrades, interior finishes, and project management. They’re essential to executing the vision and design.
Step 8: Obtain Permits
Before making any improvements to a property, it’s important to know the extent of the work and whether you’ll need permits from local authorities. Permits may be required for structural changes, electrical or plumbing work, or other modifications. Not following local building rules can lead to fines, legal issues, and potential liability for any damages or injuries caused by the work. Consult with the architects and contractors that you’re working with, or reach out to your local authorities.
Step 9: Start on the Construction Phase
During the construction phase, the long-anticipated work is finally completed. This project phase is super important and needs good management to keep things running smoothly. How long this phase takes can vary based on the complexity of the project, but keeping everything on schedule is key to the whole project’s success. Once this phase is complete, the business can open for regular operations.
Important Note: If permits were required for some work, you may need to have a building inspector visit the property to make sure that the work was done to code and is approved.
Why Are Commercial TIs Important?
Commercial TIs are a win-win for landlords and tenants because they help make the most of the space and boost profits. Landlords strengthen their relationships with tenants by designing a space that helps tenants thrive, leading to longer lease agreements. On the flip side, if commercial spaces don’t cater to what businesses need, the impact can be serious, like high turnover and lower rental income. Let’s look at why these improvements are so important for landlords and tenants:
| Landlords | Tenants |
|---|---|
| Attract high-quality tenants | Positively impact operations |
| Increase occupancy rates | Boost employee productivity |
| Leads to higher rental yields | Attract more customers |
Frequently Asked Questions (FAQs)
Can a tenant remove improvements?
Removing improvements depends on the terms of your lease and the type of improvement it is. However, generally speaking, a tenant cannot remove improvements if paid for by the TI fund, as these improvements technically belong to the landlord.
Are tenant improvements an operating expense?
Tenant improvements are typically not considered operating expenses; they are usually considered capital expenses.
What is the difference between tenant improvement and building improvement?
Tenant improvements are specifically for the tenant leasing the space at that time. For instance, if a restaurant occupies a space, its improvements will be tailored to meet the needs of its business. Building improvements address the requirements of the entire building, benefiting all tenants. An example of building improvements would be structural repairs.
Bringing It All Together
In commercial real estate, tenant improvements are common, especially in the office, retail, and medical industries. Now that you have a better understanding of commercial tenant improvements, you’ll be able to meet the needs of your tenants and form long-lasting business relationships with successful lease terms.
Do you have any success stories to share about making improvements to your property?
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