LEASE AGREEMENT REFERENCE GUIDE 1480: STRATEGIES FOR CONSTRUCTION ALLOWANCES $49.95
Drafting the Pro-Tenant Work Letter Addendum
Focusing on the Venerable Construction Allowance
This LARG examines the construction allowance—an ubiquitous exhibit in commercial leases. The allowance allows the landlord to determine its maximum construction costs for the premises when the lease is executed, and it assures the tenant that the bulk of the improvements for its space will be funded. Even so, there are still plenty of issues to fight about when the deal is negotiated.
The first portion mulls over the mechanics of the allowance and takes a look at which construction costs should be expressly covered. The balance of the publication compares excerpts from two construction allowance exhibits—one for a retail tenant doing its own work, and the other for an office tenant content to have the landlord’s contractor build out its premises.
Getting Specific About Construction Allowance Exhibits
Landlords of all stripes (i.e., office, industrial and retail) frequently use the construction allowance as a key ingredient in their deals. This device sets aside a lump sum of cash to fund the construction of tenant improvements in excess of the "base building components" or the "shell" provided by the landlord for the premises. The construction allowance funds the actual build out of the tenant’s premises—the carpet, light fixtures, interior walls, doors, wall coverings, all as detailed in the improvement plans prepared by the tenant and its design consultants, and approved by the landlord according to the work letter for the deal. Since the landlord has a firm number for the cost of tenant improvements, the landlord can calculate the rent for the deal without guess work concerning construction costs for the premises.
If the tenant builds its own improvements, the allowance cash is normally disbursed to the tenant after their completion, and usually after the satisfaction of certain other conditions. If the landlord is building the tenant improvements for the tenant’s account, the landlord funds that construction with the allowance. If the cost of tenant improvements exceeds the amount of the allowance, it is up to the tenant to pay for the excess.
Bricks and Mortar, Per Square Foot
Construction allowances are often calculated on a per square foot basis (e.g., $28 per square foot) and usually relate only to "bricks and mortar" improvements in the premises as opposed to moveable or removable trade fixtures. Allowance documentation generally excludes equipment for office tenants (e.g., computer or communications gear) and merchandise or removable retail fixtures purchased to stock a retail tenant’s premises.
Allowances are often expressed as the lesser of a certain dollar amount or the actual cost of the qualifying improvements made to the premises. If the tenant improvements are projected to cost less than the allowance, it is up to the tenant to negotiate language in the exhibit requiring the landlord to pay the balance of the allowance to the tenant when construction is complete.
Over the years landlords have become more sophisticated regarding the conditions that govern actual payment of the allowance to the tenant when the tenant is responsible for the actual construction of the improvements. Ordinarily, the landlord prefers to pay the allowance in a lump sum after all the improvements have been completed without liens, and after the tenant has opened for business in the premises.
Not surprisingly, tenants constructing their own improvements have a different point of view concerning numerous conditions to payment imposed by many landlords. Sophisticated tenants bargain for progress payments of the allowance so that they can disburse portions of the allowance to their own contractor as work is completed in the premises.
Frequently, the allowance is payable to the tenant within a certain time after the last condition to payment is satisfied. Conditions commonly imposed by landlords for payment include: