TI versus Free Rent

In what situation would a company offer a tenant either free rent (3 months for example) or TIs? What are the benefits of issuing TI as opposed to free rent for a certain time period?

If you would like to attract a retail tenant, how would you structure the deal?

 

It may seem to be more profitable to go with free rent – as opposed to providing an initial TI allowance. However, the provision and subsequent monitoring of the TI allowance will ultimately increase the value of the prospective unit. Hence, the initial cash outlay is justified by the generation of greater potential rents in the future, i.e. after lease expiration or option negotiation.

Now this is a very simplistic overview, as it important to analyze the prospective tenant’s lease and credit, especially in the current retail market – thanks to Amazon. If the tenant has a kickout option after year 2 and/or its lease is only guaranteed by an individual franchisee, you are not going to handout $80/sf.

 
Best Response

Completely depends on what they want. If they do not want to come out of pocket on the deal for build-out, TIs may be more valuable to them as they can build the space they want without spending additional capital. If they want to reduce their bottom line monthly expenses, they may be more likely to opt for free rent. Both amounts being equal, better to give TI and require the tenant to invest it in the building (ie limit the amount they can spend on FF&E to 15%). That way when the tenant leaves you get improved space that may be re-leased at a premium, whereas free rent disappears into thin air. Additionally, it's often harder to lease other space in your building if your comp is on the street at a high free rent allowance--it can set the benchmark for other deals in the building. Whereas TIs are a bit more individualized to tenant needs, the rent you are generating, etc.

 

You can also use TIs to buy better deals for your building and put your assets on the map. The best restauranteurs in many markets will expect you to come out of pocket on TI allowances way higher than market...ie, at $50 NNN rent and $300 in TI. While this is very risky from a capital investment standpoint (restaurants generally have garbage credit), you may be able to draw traffic to your building, create some buzz/hype etc. that can drive leasing activity elsewhere (office above). Sometimes you can work in a percentage rent clause to share in the spoils if the retailer crushes it, although that is more rare nowadays.

 
centaurcre:
Why can't TI be included in the NER calculation? Whenever I calculate NER I amortize the TI cost into the deal term. Could you help me understand the downside of this?

Thanks!

What you are doing is absolutely correct, and should further be the industry standard. However, I always receive OMs from brokers that brag about the high net effective rent for a stabilized asset, while conveniently forgetting to include the TI figures provided to existing tenants.

Case in point: We were evaluating an office building in Chelsea that had a restaurant on the ground floor. The rent on a psf was much higher than its comps. When we finally saw the lease, we found that the landlord bent over and gave a ludicrous and astronomical amount of TI for a kitchen build out.

Another thing I embarrassingly learned the hard way, is always compare the projected TI figures in the Argus model to the TI that was given to existing tenants (via the leases). It is comical when you see TI forecasted 10 years from now to be a third of the value that was given 5 years ago.

 

Landlord fatigue can drive free rent vs TI's. I'm booking a small lease next week on space for a client. The owners are brokers and have spent a year rehabbing this mixed us project. They are done, and I mean done with anything involving spending money on this property with regard to construction, lol.

We got 90 days free rent and access for tenant paid TI's 30 days before occupancy.

 

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