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How to Negotiate a Lease with a Tenant Improvement Dollars Offering

By: Bruce Carter

Bruce Carter

Even though banks are starting to lend again after an almost complete stoppage during the recession that started in 2008, borrowing money for a renovation or new club can still be a daunting task. For that reason, some club owners are getting funding from landlords because landlords have a stronger motivation to negotiate as they need to rent empty, non-revenue generating space.

Although it is a buyer’s market today, landlords still want credit-worthy tenants, especially if they are contributing tenant improvement (TI) dollars. So they will look for strong credit and assets, and they usually ask the tenant to sign personally on the lease (unless the tenant is a large chain).

Negotiating a successful lease involves determining the basic parts of the lease, such as rent amount, length of lease, options and free rent, but it also involves negotiating the landlord’s contribution to a build-out and making sure you get the most value for the dollars being allocated.

Landlords provide tenant improvement dollars in two ways. The landlord can allocate a certain amount for your build-out (such as $20 per square foot), and you then determine how you allocate the money on leasehold improvements. This is the most desirable way to negotiate the lease, but the landlord will require invoices on where you spent the money. The landlord usually releases the money in payments as work is done or after it is completed. You usually cannot spend the money on things such as promotions or exercise equipment because it has to go to improving the space.

You usually pay this money back through your rent, which will increase accordingly. But, after you have paid back the TI dollars through your rent, the rent often will not decrease. Instead, it will remain at a higher rate, and rent will continue to increase from that number.

Even though this seems like a bad deal, it is a popular option because money is easier to get from the landlord than from the bank. Also keep in mind that by offering you money, the landlord is taking a significant risk because if you go out of business before the lease is up, the landlord usually ends up losing what has not yet been paid back.

Other Loan Options

The second TI loan option involves the landlord controlling how the TI dollars are spent. In this option, the landlord often does some of the build-out themselves using the TI money, but problems can arise. Often the landlord may spend $20 per square foot in their own way, but the tenant does not get a full $20 per square foot of value. A large landlord typically will pay higher amounts for build-out, so what the landlord gets done for $20 per square foot, the tenant could have gotten done for cheaper by getting several bids for the work.

To prevent this from happening, you first need to negotiate that you have final say on how the money gets spent and the right to get your own bids for certain work if you feel the landlord’s cost is too high. Ask that the landlord itemizes all items associated with the cost. Landlords may not accept these lower bids because they may be concerned it will equate to inferior work. To avoid disputes, agree upon a process for when lower bids will be accepted. I would also suggest working with licensed contractors who can let you know when a price from the landlord is too high.

Usually before a landlord will agree to any build-out dollars, they will want to see the space design, but they do not pay someone to do a layout until you have negotiated the basic rent and terms of the lease. If those terms are acceptable, then it is potentially OK to spend the money on a preliminary design. The more money the landlord contributes, the more likely a layout will be needed for the landlord to negotiate the specifics of the funding. If the landlord is going to pay and do the actual construction, then specific drawings (such as electrical, plumbing, etc.) will be needed so the money can be correctly allocated.

The key is to spell out in detail and in writing the agreed-upon plans and drawings. If you do not do this, discrepancies will come up regarding who will be responsible for paying what, and unless it is in writing, the landlord or contractor will not pay for it.

Having a landlord contribute to your club’s construction costs usually is a positive step, but costs and outcomes may vary. Paying close attention to detail and asking questions about how the money is spent are critical to getting the best deal and being happy with the end result.

As published on clubindustry.com, August 2013.