First time Commercial landlord need direction on "TI" in a deal

9 Replies

I am the owner (Inheritor) of a building that used to be a bar in Phila. Pa. Someone is interested in leasing the property but it needs appx. 70K in work to get it where they want it. I understand I am obligated to pay back the money invested in my property. My question is how can I pay it back with out taking money directly out of my pocket? Could rent abatement be a tool? What options do I have. The tenant is willing to pay the TI up front. 

Typically, there is a TI budget ($/sqft) you give to tenants.  Ask local broker for a range based on your property type.  Yes rent abatement can be used to compensate for TI.  I would have the rent abatement be spread out or drawn out over time. Give a month free or reduced rent at the beginning then give them a free month on the first month of the second year as long as they pay rent on time, for example. 

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Gavin, 

It sounds like you are referring to a Tenant Improvement Allowance, is that correct? If so, you (the owner) pays money to the tenant as a contribution towards the deal to go towards some of the fit-out costs. Due to the high failure rate of bars, unless they have significant experience, have solid financials, the bar is in a good neighorhood (e.g. Northern Liberties, Rittenhouse Sq), and have a proven concept, I would tread lightly with making a TI contribution to the Tenant. I would offer a free rent period after opening in lieu of a TI contribution, and negotiate from there. Different ways to skin that cat...for example if you gave 6 months of free rent on a 10 yr term, you could structure it as "3 months of free rent after opening plus one free month at months 13, 25, and 37 of the term", and then extend the term 6 months to be a 10 yr and 6 mo term. If you do ultimately give some TI $ to the tenant, if they close early be sure to include language that the tenant is responsible for the repayment of the  unamortized portion of the allowance. 

Damon

Gavin,

Tenant Improvement Allowance (TIA) is a negotiated item, so it's only obligated if you agreed to it. For most small / individual operator Tenants, I would tread carefully on agreeing to any TIA to the Tenant. It does seem like most Tenants today are accustomed to asking for TIA from the Landlord, so if they push hard for it, your initial position should be to offer some 'free rent' after opening rather than writing a check; if they push back on this, then if the deal terms make sense (high enough rent, long enough term, strong enough financials/signature), and it's a good concept, perhaps offer a combo of some free rent and a little TIA. Also, keep in mind, if you do agree to provide some TIA, NEVER pay it up front, it should be paid as a reimbursement typically within 30 days of opening of business, receipt of first month's rent, and receipt of all lien waivers. Also if you make a TIA payment, you should negotiate what the money can go towards (e.g., permanent fixtures).

The real question becomes is this a (tenant in the moment) meaning they inquired and you just want the place filled OR have you contacted a leasing broker to perform a void analysis?

The void analysis tends to show for that immediate area the demand for the space will likely be (national tenant, regional, local mom and pop), and what KIND of tenant would optimally go there for type of business and rents paid.

You want to see how hard it is for bars to make money look at Jon Taffer and the turn around show bar rescue.

As a landlord as someone else mentioned you typically do not want to pay TI to tenants with a high failure rate (start up mom and pops) as you may never get it back. Instead they can do their own TI's in exchange for some free rent from CO (certificate of occupancy) period. You can put language in the lease that they will not allow liens on your property and will defend against it and only use qualified contractors at certain times of the day for construction. There is an uphill curve for a new operator that does not understand all the permits, health department criteria, county and city requirements to get approved for opening. It can be a massive undertaking. I was in the food business for decades before getting into commercial RE.

You need to look at the potential tenants personal and business financials along with the track record to see the strength of the operator. If they are weak with little to no money or experience it is high risk and might be better to leave your space empty waiting for a better tenant. Alternatively if they have a silent business partner with high net worth you get them on the hook for the guarantee of the lease. Bars that are run improperly can lose hundreds of thousands of dollars a year.

National tenants such as a Starbucks you pretty much know chances are high you get the TI back in many years of future stable rent history. Landlords for retail you need to play the percentages game to try and mitigate as much as possible your risk factors.

 No legal advice given.  

Originally posted by @Gavin Rogers:

Thanks for the responses, my question now is am I obligated to pay any portion of the TI or is that considered their cost to do business?

To answer the question in substance, a TI allowance is something provided by the LL. However, my typical approach is, make it both. Offer an allowance if the market dictates it (ask your broker), but make sure THEY also have skin in the game. You don’t want to give someone $70,000 to pay for 100% of the upfit. In the scenario you describe, you could offer them $40,000 so you know if they leave they are walking away from $30,000 of their own money invested in their own business.

Another key is often you can amortize TI allowance into their rent. Say you gave them $50,000 on a 7 year lease. Calculate the monthly principal & interest payments on a $50,000 loan over 7 years and add some of all of that number to their rent. Your broker will be a key partner in this discussion.

When a tenant insists on TI money, and if they are not a national credit, I typically ask for their projected build out costs. I then would agree to an amount based on part of their budget, ask for receipts of actual build out costs as it progresses, then if all adds up, pay up my TI money over a one year period after opening.

@Gavin Rogers - there are some great answers above.  

The very short answer to your question is- everything is a negotiation in a commercial lease. You could, if you wanted, provide free rent in lieu of a TI allowance. This could be done a Gross basis or NNN - once again, however you can negotiate.

So, no, you don't have a pay any TI's.  There are some landlords that refuse to put money into their properties and prefer to have the tenant do all the work.  In those situations, generally lower rents and sometimes less qualified tenants.

The tenant, if they've been at it a while, may sense that you have not owned commercial real estate before and is pushing hard for a better deal.  That's not uncommon.

Just keep in mind- if you have a desirable property in the good location- he needs you just as much as you need him.

Now, let's say you both want to do business- what next?

In comments above the conversation around credit worthiness came up. This is a big deal in CRE. Same rules apply to leasing your commercial property as if you were renting out your house.

- can they pay?

- how strong are their financials?

- do they have references?

For ex- I'm leasing up a retail property I'm developing now.  I have a National tenant with a very strong balance sheet.  They are providing Corporate Guarantees.  I take this to my bank and they see the tenant and what I need to provide for TI's (because it's a new build- we are at $15 psf).  For some of our other tenants, we may be $20-25 psf.

But, the lease rate will be influenced in part by my TI's, tenant covenant, length of lease etc.

Hope that helps.