Here’s my list: (1) is use of the money restricted to only certain purposes; (2) what happens if all of the money isn’t spent; (3) how are tax obligations affected; (4) what conditions, if any, must be met before the check is written; (5) should the landlord get any part of the money back if the lease is prematurely terminated; (6) what happens if the landlord doesn’t pay the allowance; and (7) should the lender pay the allowance if it takes the property over before the money is paid? If any reader has another issue to list, just let this lone blogger know because he is going to tackle this subject in three or four separate postings, beginning with (1) and (2).
The first item, “(1) is use of the money restricted to only certain purposes,” can be easily dismissed as a business matter. But, that would be slinking out because we need to ask: “what is the principal reason the money is being paid in the first place”? To a tenant, tax and accounting considerations aside (but, they shouldn’t be ignored), money is money. It is fungible. If a project requires real property improvements of $10 per square foot of floor area and requires store fixtures costing $10 per square foot of floor area, it really doesn’t matter to the tenant’s bank account what an $8.00 per square foot tenant allowance is called (though it will mean something when is comes time to do a tax return or a financial statement).
To a landlord, “cash is also cash,” and regardless of the purpose to which a tenant applies the tenant allowance, the money is gone. Yes, there are also tax and accounting implications to a landlord depending on how the money is used, but as far as its bank account goes, the money is gone regardless of how it is spent, even if the tenant doesn’t spend the money. On the other hand, it might matter to a landlord if the landlord is counting on certain improvements being made to the leased premises by the tenant. A simple example would be where the landlord is expecting its tenant to upgrade or replace the HVAC. But that’s not really a Tenant Improvement Allowance issue, it is a lease enforcement issue. While the money might be an incentive for a tenant to “do” the HVAC, tying the Tenant Improvement Allowance to the HVAC would only be a proxy for a lease default provision. So, to me, if the deal is that the tenant is required to replace the HVAC (or do some other mandatory work to the leased premises), say so in the lease and say it directly. Make it a default if the tenant doesn’t do what was promised. The Tenant Improvement Allowance doesn’t have to be tied to the HVAC. Release of the money, whatever the lease calls it, can be conditioned on such things as the tenant opening for business, paying its first rent installment, getting a C of O, furnishing lien releases, AND completing the HVAC. That’s different than insisting that the money actually be spent on the HVAC.
I know I haven’t yet answered the question of whether the use of the money should be restricted to certain purposes, but perceptive readers will have gotten the drift – I don’t think so unless tax or accounting reasons wag the dog, and sometimes that might be the case. A later installment of Ruminations will “go there.”
The preceding comments actually lead right into the next and admittedly even more controversial issue – “(2) what happens if all of the money isn’t spent?” I won’t pull any punches; my answer is: “it still goes to the tenant.” Why, you ask? My answer is: “it was in the rent.” Assume we are talking about the same “as-is” space available for lease. Would the rent be the same if the landlord was giving a $20 per square foot allowance as when there is no allowance? Of course not! Would the rent be the same for an “as-is” space and the same space delivered “turn-key” by the landlord? Absolutely not! So, there being no “free lunch” in this world, the tenant is paying back the Tenant Improvement Allowance as part of its rent. Yes, give me $20 cash per square foot up front, and I’ll pay you $2 more per square foot rent on a ten year lease. Those may not be the numbers, but that’s certainly the principle. What’s the implication of this principle? It’s simple, either pay the entire allowance or lower the rent. So, if it isn’t all disbursed, the rent needs to be adjusted.
Having gotten that off my chest, it is easy to see why, absent tax or accounting concerns, sometimes relevant, sometimes not, I think the use of Tenant Improvement Allowance moneys should be unrestricted – use it for real property improvements, fixtures, inventory, advertising or hiring – even to buy one or more rounds of drinks. Dance around the issue all you want, but Tenant Improvement Allowance money is really the functional equivalent of a loan from a landlord to its tenant to be paid back as part of the rent.
One last thought from this Ruminator before closing shop for today – the honest name for this money should simply be “Tenant Allowance.” See the comments above to understand why.
Questions (3) and (4) are being queued up for next time – (3) how are tax obligations affected; and (4) what conditions, if any, must be met before the check is written?
Comments, thoughts, outrage? If you have any, let Ruminations know at www.retailrealestatelaw.com.