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.