An Improvement Allowance - A Primer

I recently authored a piece entitled "The Commercial Real Estate is ALMOST Perfect - Now what?". If you missed the missive, no major misstep - you can click the link and get up to speed. One of the excerpts I want to explore today is:

"Once the true cost of the new offices is determined, we now must negotiate who pays - you, the owner, or some combination of you and the owner. Generally, an owner will be reluctant to pay for an improvement that adds value today but may need to be ripped out in the future."

There are circumstances in which an owner will in fact write a check, as a concession, for improvements to a space - in the case of a building in shell condition, or if the building is in need of some updating and the owner prefers to throw a wad of cash at the problem vs. doing it himself.

What follows are some issues to understand before you negotiate changes to the space.

What is it. By definition, an improvement allowance is a sum of money the owner of a building will invest in improvements to his building. These improvements could be new offices, new flooring, paint for the offices or warehouse area, expanded electrical circuitry, or truck door enhancements such as load levelers.

Turn Key vs an allowance. In a turn-key situation, you are requesting your new layout be entirely created by the owner of the building without a cost to you, the occupant. An allowance conversely, is a fixed amount of money the owner will spend on your layout with no guarantee the sum will cover the entire cost. If an allowance is all you can muster, make sure you understand the true cost of your improvement with adequate wiggle room in case of a surprise.

Not all deals. Understand that not all transactions will offer an allowance for improvements. We frequently see this in industrial deals. An owner will possibly freshen the offices with a coat of paint and some new flooring but will be unwilling to do much more.

What an owner will pay. Generally, an owner will pay for "general purpose" improvements - those that will be re-usable by future tenants.

Ways an allowance is paid, when and how. The best for you, the occupant is to have the owner provide a turn-key allowance as a concession. He produces your layout with no cost to you other than your timely rent payments throughout the term of your lease. The worst for you, the occupant, would be a complete repayment, with interest, of the improvement dollars the owner invests in the building.

SNDA. If a substantial investment is needed to shape your space into habitable form, make sure the lease you sign includes a Subordination, Non-Disturbance, and Attornment provision. Simply put, this clause will protect your investment and tenancy if your owner loses his building - your business home - through  foreclosure.

Management fee. One of the "gotchas" that exist within an allowance is the owner's right to charge you a fee for managing the process of building your improvements. Let's say the owner will invest $100,000 to mold your arrangement. Your construction costs $100,000. You're golden! Oops, the owner is charging you $5000 to oversee the construction. Now, your new arrangement is tipping the scales at $105,000 - guess who pays the $5000? Yep! The one reading this.

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You Own, you're Moving - Now What?

Recently, I authored a post wherein I discussed making the ends meet in a commercial real estate deal. You can read the post here if you missed it.

During my discussion, I grazed a topic which today will receive a larger nudge - if you own your building and have elected to relocate, should you lease or sell the vacant building you leave behind?

A move generally is bittersweet - a cause for celebration because an increase in business created the need for more space. Good for you! But, the additional sales spawned another problem - you will create a vacancy. Now what?

In short, the direction you choose in dealing with the excess space and filling the vacancy depends upon several factors. Indulge me while I dissect a few of them.

The structure of your new deal. Are you buying the new building, leasing the new building or leasing the new building with an option to buy the new building at a later date? Chances are, if you desire to own the new spot and don't have a pile of cash lying around, you will need to sell the building you're vacating. Conversely, if your next space will be leased, you may be able to hold on to the old address.

Your desire to be a landlord. Owning and managing a leased building occupied by a company - not your own - comes with a set of headaches - and not necessarily a bottle of aspirin. Some of the painful biggies - who will vet the credit of the new occupant, what if the new guy fails to pay, can you float a lack of rent while you scour the market for a suitable occupant?

Can you afford to lease the existing building? Here is what I mean and how I counsel companies facing this dilemma. The market is the market. Prospective tenants will only pay you a rent figure for your building based upon what has leased recently and what other buildings are demanding in rent. So now you must roll up your sleeves, compute your costs to own the building (mortgage payments, property taxes, insurance, maintenance), add a reasonable return for the equity you have in the building and see where that squares with the market rent. You may believe yours is worth more. Maybe, but are you willing to wait? Remember, waiting is expensive. Lost rent for all the months you wait can never be re-cooped.

Do you require the vacant building's equity to fund the new location? This one is easy. I recently represented a group based in Whittier. So far past the building's capacity was their operation, we practically had to meet in the parking lot. I advised the company to move out, lease a new location with an option to buy, sell the original building and once sold, trade the equity into the new building. Had this company not wanted to own the new location - thus the equity wasn't needed - the advice might have varied and a lease of the relinquished building considered.

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