Definition
Tenant Improvements (TI) are the construction, finish, and build-out work required to make a commercial space functional for a specific tenant. TI can include everything from basic interior finishes to full reconfiguration of walls and systems. TI costs are often negotiated in the lease through a TI allowance (a landlord contribution, usually expressed as dollars per square foot).
What TI Typically Includes
TI scope depends on the property type (office, retail, industrial) and whether the space is second-generation (previously built out) or a raw shell.
- Layout & construction: demising walls, offices, conference rooms, back-of-house buildout.
- Finishes: flooring, paint, ceiling, millwork, lighting upgrades.
- MEP work: HVAC distribution, electrical, plumbing, fire/life safety adjustments.
- Code compliance: ADA upgrades, permitting, inspections, life-safety requirements.
- Specialty build-outs: medical plumbing, venting, grease traps, soundproofing, lab specs.
How TI Is Paid For
TI economics are a key part of “what rent really is.†Two leases with the same face rent can have very different value once TI and other concessions are included.
Common structures
- TI allowance: landlord funds TI up to a stated amount (e.g., $40/SF). Tenant pays overages.
- Turnkey: landlord delivers a finished space to an agreed spec for a bundled rent package.
- Tenant-funded: tenant pays TI (often for highly specialized use) and may negotiate lower rent.
- Amortized TI: landlord funds TI but charges additional rent to “pay it back†over the term.
Why TI Matters
- Leasing cost: TI is a major component of the “cost to sign a lease,†along with leasing commissions.
- Net effective rent: higher TI can reduce the economic rent after adjusting for upfront costs.
- Cash flow timing: TI is an upfront cash outlay that can pressure liquidity and reserves.
- Tenant retention: TI may be used as a renewal incentive, reducing downtime and vacancy risk.
- Re-leasing risk: specialized TI can be hard to re-tenant without expensive reconfiguration.
How Investors Underwrite TI
In commercial underwriting, TI is typically treated as a leasing capital expenditure (leasing capex) rather than a normal operating expense. Investors forecast TI needs based on lease rollover, market standards, and tenant type.
- Budget by suite type: office and medical often require higher TI than industrial warehouse.
- Consider rollover: expiring leases create future TI/LC (leasing commission) requirements.
- Use market benchmarks: TI is often quoted in $/SF and tied to term length.
- Stress test: higher TI + downtime is a common downside scenario in soft markets.
Example
A landlord signs a 10,000 SF office lease with a $50/SF TI allowance. The maximum landlord TI contribution is:
- TI allowance = 10,000 SF × $50/SF = $500,000
If the build-out costs $575,000, the tenant typically pays the $75,000 overage unless the lease provides for landlord-paid overages or amortization through higher rent.
Common Pitfalls
- Confusing face rent with value: ignoring TI can overstate true lease economics.
- Underestimating permitting/timing: delays can extend free rent and push move-in dates.
- Not separating TI types: “new lease†TI is often higher than “renewal†TI.
- Over-specialization: highly tailored TI may create expensive re-tenanting later.
- Weak scope control: change orders can blow budgets without tight project management.