Protect Against Potential Downsides of Tenants' Improvements

Suppose a tenant leasing your commercial property wants to improve that property and wants you, the property's owner, to help pay for those improvements. Owners sometimes agree to do so by paying for the amount that those improvements cost the tenant beyond a certain dollar amount per square foot.

“Up to the amount of the agreed-upon credit per square foot, the tenant can order work from the owner at no cost to the tenant,” explains Marc Ripp, senior associate general counsel at the Mack-Cali Realty Corporation and a CLLI Advisor. “If the tenant orders work that costs more than the construction credit, then the tenant must pay the owner for that excess cost.”

Commercial property owners often allow tenants to repay that excess cost in one of two ways. “Some owners require the excess cost to be paid immediately and in full before the work is commenced,” Ripp says. “Other owners will agree to ‘amortize’ the extra costs—that is, spread out the cost in equal monthly installments over the full length of the lease term.”

According to Ripp, who recently represented a client who afforded its tenant a construction credit of $20 a foot, amortizing the cost beyond the allotment can have downsides for a commercial property owner—unless the lease contains certain safeguards.

Get Three Safeguards

First, owners in this situation should charge interest on the construction costs that go beyond the agreed-upon allotment. “Without an interest charge, the owner is giving an interest-free loan!” Ripp explains.

Second, Ripp advises, commercial property owners' leases should impose a maximum dollar cap above which the tenant may not amortize the costs of the tenant's improvements. “Without a maximum dollar cap, the owner is allowing the tenant to borrow an unrestricted amount of money!” Ripp says.

Finally, Ripp advises, “If the excess cost of the tenant's construction is equal to or less than the cap, all of the extra costs could be amortized. Any amount above the cap, however, could not be amortized and would have to be paid immediately and in full before the work is commenced.”

Insider Source:

Marc L. Ripp, Esq. Sr. Associate, Gen'l. Counsel, Mack-Cali Realty Corp.; Edison, NJ