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Over the last few years, tenant improvement projects have been on the rise as hybrid and remote work trends persist and owners face increased competition for office tenants. Landlords, in an effort to attract tenants and secure long lease terms, have started offering allowances, among other concessions, like free rent. Office leasing trends, which have been in decline following the rise of remote work during the COVID-19 pandemic, will likely continue to drive rent incentives up in the near future.
Leasing trends in the post-COVID era show that the majority of office space tenants are looking for space in Class A office buildings, with creative style, smart workspaces, space for socialization, and amenities or services. Class A buildings, which incentivize workers back to the office, have continued to perform well in an asset class in an otherwise struggling office market. The majority of tenant improvement allowances have been for new, desirable office space, where renters are likely to invest in a long-term lease that allows owners to recoup the upfront investment.
Here’s what you need to know about the state of tenant improvement allowances, and what rent concessions mean for your portfolio and the market at large:
The Rise of Tenant Improvement Allowances (TIAs)
Tenant improvement allowances (TIAs), also called fit-out or build-out allowances, are a pre-negotiated amount of money a landlord will provide to a tenant to cover the construction cost. The money is meant to go toward structural improvements such as walling, flooring, HVAC, elevator repairs or replacements, and new plumbing or electrical installments. Funds can also be used for layout adjustments, such as moving inner walls or reworking flooring. TIAs allow businesses to customize their office space, and have a financial safety net for permit filing and space adjustments.
Tenant improvement projects are mutually beneficial for owners and tenants. Landlords have been struggling to fill leases ever since remote work ushered in a period of uncertainty for office buildings, especially Class B or Class C buildings that lack modern amenities. On the other hand, companies renting office space are looking for Class A office space with features that will draw workers back to the office, such as health and wellness spaces, social spaces, and services that reduce work-life friction. By offering a tenant improvement allowance, tenants get to be more particular about rented space, and owners can lock in leases that will deliver returns.
How Are Tenant Improvement Allowances Calculated?
TIA’s are usually expressed in a per-square-foot amount. For example, if the landlord provides an allowance of $10 per square foot, and the building is 25,000 square feet, an allowance of $250,000 will be provided. Property owners don’t require repayment of the TIA from the tenant but do often factor the allowance into the base rent or extend the length of the lease to make the funds back at a later date. Before deciding if rent concessions are a good investment, it’s important to do the appropriate calculations to ensure your asset will deliver adequate returns and your portfolio will remain profitable.
The Broader Impact and Market Responses
Key office building markets such as New York and San Francisco are case studies for the rise of tenant improvement allowances. Tenant improvement allowances in San Francisco have almost doubled since the start of the pandemic. Bay area landlords are offering up to $32.50 per square foot, a 60% increase compared to pre-pandemic. TI’A’s in the area may eventually decline as the market stabilizes, but landlords should expect concessions to stick around for the next couple of years until return-to-office efforts see more widespread popularity or burgeoning industries increase demand.
Manhattan office tenants are getting an average of 24 percent of their total rent as concessions, which includes free rent and TIAs. High-end Class A office buildings with steep rents are finding it difficult to find tenants without rent concessions. Free-rent concessions have increased exponentially in recent years, with some landlords leasing with up to 14 months of free rent. In New York City tenant improvement allowances peaked in 2022, with $147 per square foot being offered on average, and a slight dip in 2023 at $145 per square foot, according to CBRE data. For reference, average tenant improvement allowances were around $104 per square foot before the pandemic in 2019. In Midtown, Midtown South, and Downtown Manhattan, the average tenant received 17 months of free rent, and tenant improvement allowances in the three areas averaged $148, $148, and $125 per square foot respectively.
Landlords across markets, especially for Class A Buildings with higher rents and amenities, are increasingly willing to trade cash upfront for a long-term lease agreement on the office space. As a result, markets across the country have increased incentives for tenants, especially in prime office space real estate. Boston’s office market, where landlords are looking to combat the stagnated post-COVID market, is also seeing an increase in concessions eat into returns. Atlanta and Los Angeles’ owners are also seeing the office market stay firmly in tenants' favors. In general, landlords are seeing rent concessions strip 24% of rent off Class A properties across markets, but the trend will likely reverse when the market begins to turn around.
Predictions and Implications for the Future
TIA’s have historically risen during times of economic downturn, and experts see the market staying in tenants favor for the foreseeable future. Chris Okada, CEO of New York City-based firm Okada & Co., reported that over the past three years rents have continued to decline while tenant’s additional benefits have continued to increase. He noted that tenants willing to pay top dollar understand their advantageous bargaining position, and are looking to negotiate better deals ahead of lease signing.
Okada noted that the TIAs tend to rise and fall in cycles. He highlighted the dips in office occupancy during past economic downturns, including the great recession, the dot com bust in the 90s, and after 9/11. “People in business for more than 20 years have seen this before numerous times and know rents can recover quickly and double,” Okada said. “There’s always a new wave of space users that come in and take up more square footage, it happens every single economic cycle,” Emerging industries like AI, according to Okada, could lead a recovery in the office space market.
Landlord and tenant relationships for office space assets will be shaped by the ongoing prevalence of remote and hybrid work into the next year and beyond. Office space trends are showing that, even amid declining tenancy and rents, Class A office space remains resilient. Owners with capital to spare can recoup the initial costs of a rent concession or allowances for tenant improvement projects.
In the face of an uncertain market, remaining adaptable in the market and conducting thorough due diligence on your projects is more important than ever. Modern real estate development software can help you create budgets that allow for tenant improvement allowances or other rent concessions on office building assets. Northspyre’s platform can help you create accurate budget forecasts and prevent overruns in the development process, ensuring your projects remain profitable in any market.
Discover how Northspyre can help you manage your entire real estate portfolio and keep your team organized, on-track, and on budget by booking a demo today.
Tag(s): Real Estate Development