Real Estate Blog
Show Me the Money! Negotiating Tenant Allowances
Tenant Allowances are cash contributions made by a landlord to a tenant to prepare the premises for business. Landlords offer these funds to draw tenants to their developments and subsequently recoup their investment through a rent increase. When it comes to Tenant Allowances, landlords and tenants should consider the following issues:
- Uses. The lease should clearly define the types of costs for which the Allowance may be used. Landlords may want to limit the Allowance to items that will provide lasting improvements to the premises and benefit the leasehold at the end of the term. Landlords should exclude any payments to the tenant or its affiliates, as well as costs resulting from tenant’s default under the lease, and financing costs. Tenants may want to use the Allowance for project management, design, engineering, permitting, trade fixtures, personal property (such as furniture or equipment), and moving expenses.
- Amount. Allowances may be a fixed dollar amount or limited to a maximum amount; if a fixed amount, the lease should specify whether tenant receives any balance due as a rent credit or a payment from the landlord. On the other hand, if the Allowance is limited to a maximum amount, and the full Allowance has been factored into the rent, tenant may be entitled to a rent adjustment if less than the maximum amount is disbursed. Landlords should also reserve the right to deduct any amounts owing from tenant to landlord under the lease.
- Timing. Landlords may prefer to pay Allowances in a one-time lump sum after tenant completes its work, has satisfied all conditions to payment (discussed below), and is open for business. However, tenants generally want the Allowance paid as soon as possible and may not be able to finance improvements without earlier payments. Payments may be structured based upon an agreed upon timeline, a percentage of work completed, in monthly disbursements, or within a certain number of days after invoices are submitted. Landlords should set a date by which tenant’s last request for disbursement may be submitted so that landlord can close its books. The lease should also specify whether payments will be made to tenant, or directly to the contractor.
- Conditions. It is critical that landlords impose certain conditions before all or a portion of an Allowance is paid. These include providing partial or final lien waivers from tenant’s contractor and subcontractors, suppliers and materialmen, and tenant not being in default at the time of the disbursement. Other requirements may include architect’s certifications that work has been completed in accordance with the construction contract, receipted invoices marked “paid” showing the amount of tenant’s payment, a permanent certificate of occupancy for the Premises, and delivery of “as built plans.”
- Landlord Default. How does tenant protect against landlord’s failure to pay the Allowance? Tenant should reserve the right to offset any unpaid portion of the Allowance (with interest) against future rent. Landlord may negotiate for a notice and cure period to limit offset to a certain percentage of base rent. Tenant may try to secure landlord’s payment of the Allowance by requiring that funds be deposited in escrow, a letter of credit, or a guaranty, particularly if tenant has concerns regarding the landlord’s financial condition.
- Tenant Default. Landlord should determine that tenant is creditworthy and has adequate funds to complete construction and open for business. If the tenant defaults under the lease, the usual landlord remedies do not include recovery of amounts advanced under a tenant allowance. Thus, the lease should provide that, in the event of termination due to tenant’s default, tenant will repay landlord an amount equal to any unamortized portion of the Allowance. Landlords may also require additional security from tenant in an amount equal to the cost of tenant work (as set forth in the construction contract) in the form of a letter of credit, guaranty, or security deposit.
- Related Lease Clauses. Landlords are advised to include yield-up clauses that specify that any improvements financed by landlord become the sole and absolute property of landlord at the expiration or earlier termination of the lease. In addition, tenants should be required to fully and completely indemnify landlord against any mechanic’s lien or other liens or claims in connection with the improvements, and discharge or bond over any lien filed for work done or materials furnished to the premises within ten (10) days after notice of such lien. If tenant fails to do so, landlord should have the option to do so at tenant’s expense.