Franchisee Real Estate Lease: TENANT IMPROVEMENT ALLOWANCE

A tenant improvement allowance is a negotiated amount of money the landlord agrees to provide to the franchisee (tenant) to help pay for the cost of improving or building out the leased space.

Contact Neufeld Legal PC for franchising legal matters at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

The complexity of the lease agreement for the commercial real estate that is used in the franchise operation can very easily equal, or even surpass, that of the franchise disclosure document and the franchise agreement, such that retaining the legal services of an experienced lawyer to decipher, explain and negotiate the commercial lease agreement and its schedules. And for over 25 years, we have been working with business owners, including franchisees, to understand and deal with commercial lease agreements that have been presented by landlords and are foundational to their business operations. To gain the most from our legal analysis and advice as to the commercial leasing arrangement, a franchisee would be well served to understand some of the most significant commercial leasing terminology, which we have undertaken to provide you with in-depth analysis.

A tenant improvement allowance is a negotiated amount of money the landlord agrees to provide to the franchisee (tenant) to help pay for the cost of improving or building out the leased space. This is a crucial financial component of most commercial leases, especially for office, retail, and industrial properties that need to be customized for a tenant's specific use.

A tenant improvement allowance typically works as follows:

• Negotiation: The tenant improvement allowance is one of the most heavily negotiated terms in a commercial lease. The amount is typically expressed as a dollar amount per square foot (e.g., "$20 per square foot"). A landlord's willingness to offer a high tenant improvement allowance often depends on factors like the length of the lease, the tenant's financial strength, and the market conditions. In a competitive market, a landlord may offer a higher allowance to attract a desirable tenant.

• Use of Funds: The tenant improvement allowance is almost always for specific improvements. It cannot be used for operational costs or furniture. The lease will list the approved uses, which may include:

  • Construction of walls, floors, and ceilings

  • Installation of electrical, plumbing, and HVAC systems

  • Lighting and fixture installation

  • Finishes such as paint, carpet, and cabinetry

• Disbursement: The funds are not usually given to the tenant upfront. Instead, the landlord typically disburses the money in stages as the construction is completed. The tenant or their contractor submits an invoice for completed work, and the landlord pays the portion covered by the allowance. This ensures the funds are used for their intended purpose.

• Overage and Shortfall: Overage - If the total cost of the improvements exceeds the tenant improvement allowance, the tenant is responsible for the difference. This is why it's critical for a tenant to have a detailed budget and plan before starting construction. Shortfall - If the tenant's construction costs are less than the full allowance, the tenant typically does not receive the remaining balance in cash. The unused portion of the allowance is simply forfeited.

From the franchisee's perspective as a tenant, a tenant improvement allowance is important to help offset the significant upfront capital costs of moving into a new space. Without it, many tenants would find it financially unfeasible to build out a raw or "shell" space to suit their needs.

Tenant Improvement  Allowance vs. Turnkey Build-Out:

It's important to distinguish a tenant improvement allowance from a turnkey build-out:

• Tenant Improvement Allowance: The tenant manages the construction project, hires the contractors, and is responsible for any costs that exceed the allowance. The landlord provides the cash.

• Turnkey Build-Out: The landlord agrees to complete all the tenant's required improvements at the landlord's sole cost, based on a set of plans approved by the tenant. The tenant simply walks into a finished space that is ready for business. The landlord retains control over the project, and the tenant avoids the risks and responsibilities of managing construction. This is a less common option but is a very favorable position for a tenant to be in.

Naturally, how the concept operates in the specific context of the particular lease agreement requires experienced legal analysis, such that you make the most out of your understanding of the commercial lease agreement for your franchise. For such legal analysis and advice for your franchise and its commercial leasing arrangements, we welcome you to contact franchisee lawyer Christopher Neufeld at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or Chris@NeufeldLegal.com to schedule a confidential consultation.

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Contact us via email at chris@neufeldlegal.com or call 403-400-4092 / 905-616-8864.