Tenant Improvements (TIs)

Part 5 in a series on the components of a purchase price allocation analysis.

Tenant improvements (TIs) are the interior build-outs that are typically customized by each new tenant to occupy a space.  These include carpet, paint, interior partition walls, cabinetry and other millwork.  

Rather than measuring the actual value of existing TIs in each space, the purpose of this exercise is to measure the cost avoidance of the typical market TI package, adjusted to match the remaining lease term in relation to the typical lease term, such that we are left with the "unamortized TI" value.

Let's say we have an office building and determine that, on average, tenants in this market recieve TIs of $20 per sq. ft. for a 5-year lease term.  Now, consider an existing tenant whose lease expires in 24 months.  One benefit to the property acquirer is avoidance of two years' worth of TIs for this tenant.  The calculation is $20/sq. ft. multiplied by the ratio of 2 yrs remaining term/5 yrs original term for a total of $8 per square foot unamortized TIs.  This $8 per square foot will be amortized over the remaining 24 months of the lease. 

TIs typically represent 8% to 12% of the total assets in office properties and 3% to 5% with industrial properties.  Some specialty uses such as medical, dental, data centers, and some retail uses will have dramatically higher TI values.  When tenant-specific improvements become extremely significant to the property, consideration needs to be made as to whether any of those improvements will survive past the current lease expiration and should be considered part of the building asset category instead (e.g. data center leases are typically written such that everything other than building shell is defined as TIs, but if continued use as a data center is probable, a large portion of those improvements might more accurately be depreciated over a longer timeframe than the remaining life of the lease).

Sometimes when a lease is secured shortly before the property is acquired, you will have a situation in which TIs are owed to the new tenant and the new property owner is assuming that liability. Careful attention must be given to the treatment of TI values in these situations.  Is the TI allowance an asset on the balance sheet for the new acquirer or are they on the hook to finance the TI package post-acquisition?  How these TIs are treated can make a big difference in the opening balance sheet.  Double-counting of the TIs is a common mistake as companies prepare their purchase price allocations.  If TI credits were given by the Seller on the settlement statement, then chances are that the new landlord will have to pay for TIs in the near future, and for the tenant in question, no value was acquired for existing unamortized TIs.

We know it can be confusing, so feel free to call Allocation Advisors with any questions about your particular situation.