In the Spotlight: Tenant Improvement Allowance — Two Perspectives

The ultimate resolution of this dilemma, like many others, depends on leverage, fairness, and negotiating skill.

How a tenant is permitted to apply its tenant improvement allowance for its build-out is frequently a controversial topic during lease negotiations.

From the landlord's perspective, the landlord is “giving” an allowance to the tenant in order to finance the tenant's construction of certain improvements to the landlord's space. These improvements are theoretically beneficial to the landlord at the end of the tenant's lease term. Because of this perspective, the landlord usually requires that the allowance be spent entirely on costs directly attributable to actual leasehold improvements, such as the hard costs of construction and certain circumscribed soft costs such as design and construction management fees. This requirement provides the landlord with the comfort of knowing that the entire amount of the allowance is invested in the landlord's building.

The tenant, not surprisingly, has a different perspective. The tenant's rent payments over the life of the lease provide the landlord with the funds necessary to advance the tenant improvement allowance dollars to begin with, so, in essence, the landlord is really “giving” the tenant its own money with which to construct the tenant improvements. Taken from this perspective, a tenant wants the unfettered ability to spend these dollars as it sees fit, including, without limitation, expenditures for cabling, furniture, moving expenses, legal fees, and, in the case of unused tenant improvement allowance dollars, a credit against future rents. Furthermore, the tenant wants the right to offset against future rents any portion of the tenant allowance that is not timely paid by the landlord.

The ultimate resolution of this dilemma, like many others, depends on leverage, fairness, and negotiating skill.