Since the topic of
a tenant improvement allowance was mentioned in the Construction Overview Section,
we’ll elaborate on this subject here.
A tenant
improvement allowance is typically a cash payment provided by the landlord to
the tenant to defer the cost of the buildout of the space the tenant is
leasing. Mathematically, this cash payment actually works out to be an interest-free
loan to the tenant which the landlord factors into the base rent, and it
is repaid by the tenant throughout the term of the lease.
Understand that this
tenant allowance also benefits the landlord due to the additional value that it
adds to the shopping center, given the increased cash flow from this higher
rent. The additional value results from a prevailing market cap rate that would
be applied to that increased cash flow in order to determine the current market
value, IF the landlord should decide to sell the property or borrow
against it. A Cap Rate is a real estate valuation method used to evaluate and
compare real estate investments. Every commercial building has a potential
market cap rate and our website can explain this concept further.
Now for an example:
Let’s assume that
the tenant is leasing a free-standing 10,000 square foot building for $10.00
per square foot, which equals $100,000 annually in base rent. Using a 5% cap
rate, the value of that building is $2,000,000. ($100,000 divided by
5%).
Now let’s add in a
$100,000 tenant allowance and amortize the repayment of that allowance over a
10-year term which will then increase the base rent to $110,000 annually. Applying
the same 5% cap rate to this increased base rent would bring the value of that
same building to $2,200,000. ($110,000 divided by 5%) – which is a 10%
increase.
So, by the
landlord providing the tenant an interest-free $100,000 tenant allowance, he
increased the value of his building $200,000, in the event that he wanted to
sell it or use it as collateral for a loan.
The amount of the
tenant allowance will always be based upon both the credit-worthiness of the
tenant and the financial wherewithal of the landlord.
Bottom line: There is NOT a down-side to a tenant
receiving a tenant allowance and it should be pursued in every lease
negotiation.