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Build-Outs and Tenant Allowances

A common aspect of commercial leasing is the building out of the premises for the tenant.  The costs of the build-out (and the hiring of the contractor(s) to perform the build-out) may be the responsibility of the landlord alone, of the tenant alone, or may be a joint enterprise between landlord and tenant.  Whatever the arrangement, build-outs are a very common area of dispute between landlords and tenants.  It is extremely important that the landlord clearly state the terms of the build-out in the written commercial lease.

The following are the some items relating to the build-out that must always be addressed in detail in the lease when applicable:

  • What improvements will be made to the premises?
  • When must the landlord work and tenant work be completed?
  • Does the completion trigger the lease and/or rent commencement date?
  • Who is responsible for the costs of the build-out?
  • Who is responsible for hiring architects and contractors to perform the build-out?
  • What is the landlord’s mechanism for approving the contractors and the work specifications?
  • Is the landlord going to pay some or all of the build-out costs?
    • If so, will the landlord pay the general contractor directly or pay the tenant?
    • Is the tenant required to pay back the costs to the landlord or will the costs be amortized within the rent?
  • If the tenant is responsible for the costs of the build-out, will the landlord pay the tenant an improvement allowance?
    • If so, when/how will the allowance be disbursed?  Will it be disbursed to the tenant or to the contractor(s)? What must the contractor/tenant provide to the landlord in order to receive disbursements of the allowance?
    • Is the tenant required to pay back the allowance?  If so, when and how?

In addition to clearly setting forth the terms of the build-out in the lease, landlords need to take additional steps to protect their property and their investment in the build-out.  The following are some tips that can help landlords avoid unfavorable results:

  • The lease default provisions should require the tenant to repay the improvement allowance and the landlord’s expenditures toward the build-out if there is a default of  the lease.
    • If the landlord is paying for the costs of the build-out, without upfront payment from the tenant, the landlord should make sure that the improved premises will be suitable for other tenants.  In the event the current tenant fails to pay rent and the landlord is forced to evict the tenant, the landlord needs to be able to market the space to other prospective tenants without tear-down expenses and another build-out.
    • The landlord should require the tenant and its owners to personally guarantee the repayment of the build-out expenses.
  • The landlord should only disburse funds for work that is actually completed.  The landlord needs to monitor the project, only pay the contractor(s) directly, and require lien waivers from all contractors before disbursing funds.