What Landlords Give and Get from Tenant Allowances

Tenant improvement allowances have benefits and risks for both tenants and for owners, as our EVP of Leasing Rebecca Waters weighs in. The following article What Landlords Give and Get from Tenant Allowanceswritten by Joel Groover is featured by ICSC in this September 2020 edition of Shopping Centers Today.

“Not only are we among the largest providers of tax revenues for local communities, but owners and developers are also the first-look lenders for many, many businesses in any respective community,” said Raider Hill Advisors founder and CEO Daniel Hurwitz. He and others in the industry say landlords need to speak out about the billions they lend to mom-and-pop restaurants, expanding big-box chains and other businesses in the form of tenant improvement allowances.

The average person has little to no understanding of landlords’ practice of granting TI allowances to support all kinds of retailers and restaurants. That matters, observers say, because the industry needs to protect its interests and lobby for better policies amid COVID-19. “The last several months have highlighted a complete lack of understanding of the beneficial role that shopping centers play,” said Hurwitz, who also is ICSC chairman.

Individual landlords often incur annual TI costs into the tens of millions of dollars. Kimco Realty, for example, provided $62.7 million in TI in 2019, according to its annual report, while mall owner CBL spent $36.3 million. “Historically, the industry has invested billions of dollars in TI allowances,” Hurwitz said. “Most retailers, including large public companies, benefit from a TI package when they initially sign a lease or exercise a renewal. It enables them to operate more profitably and use their cash in more diverse ways. There’s a huge effect on the jobs sector, as well.”

Benefits to owners, managers and developers

But owners benefit from these arrangements, too. For starters, Equity Retail Brokers principal David Goodman notes, retailers tend to pay their landlords high interest on these loans. Consider a landlord providing a TI allowance of $20 per square foot for a 2,000-square-foot space. That totals $40,000 out of pocket, amortized over the life of a 10-year lease. It would not be unheard of, he says, for the interest to run anywhere from 8 to 10 percent in such a deal, while business loans from traditional banks, according to small business resource provider Fundera, tend to range from 3 to 6 percent. “Landlords aren’t doing this solely out of the goodness of their heart,” Goodman said, “but again, they’re incurring the risk.”

Moreover, these loan and interest payments are added to tenants’ rent, and if you increase the rent, you increase the value of the center, said Rebecca Waters, executive vice president of leasing at Brand Real Estate Services, a leasing, management and redevelopment firm. “There’s definitely a benefit to the landlord.”

Benefits to tenants

TI allowances provide critical operating capital that can bolster cash-strapped entrepreneurs’ odds of long-term success. Without this spending by landlords, retailers would be forced to win loans from traditional banks, a time-consuming process that could stall their business plans, Goodman said. “Landlords put tenants through fewer hurdles than the banks,” he said. “Sometimes, tenants don’t understand the risks landlords are taking by doing that and providing that TI allowance.”

Small businesses, in particular, are prone to failure, and landlords certainly can lose their TI investments, Hurwitz says. “The landlord is in many cases providing TI dollars to individuals and businesses that don’t satisfy the criteria of the traditional commercial lenders,” he said. “There can be enormous operational risk.” These agreements also can help tenants steer clear of some adverse consequences of loading up on conventional debt. “When you have a tenant improvement allowance, that doesn’t show up on your credit report or appear as a liability on your financial statement,” Waters noted.

But owners contribute to the success of local businesses in other ways, including as business plan advisors. Even delivering a polite “No thanks” to a business’ request for a lease can help that operator in the long run, says The Parkes Cos. director of leasing and property management Rhonda Thomas. “When mom-and-pops come to us, we always ask for their business plans because we want to be sure they are well thought out. Sometimes, you get these calls from people who just woke up one day and decided they wanted to open a restaurant. Maybe they cook good fried chicken, but they have never run a restaurant before.”

Indeed, landlords around the country routinely act as de facto business consultants in their dealings with new franchisees and independent retail stores and restaurants, Thomas says. The owner might steer entrepreneurs toward resources provided by the Small Business Administration or ask them hard questions about how much cash they have on hand. “We’ll tell them they need to have enough money that, if nobody walks in the door for the first six months, they can still keep their merchandise fresh and pay their rent and utilities,” Thomas said. “It gives them something to think about.”

Once an operator has a solid business plan in place, Parkes may offer TI allowances, give the retailer ample time to secure permits and then throw in a couple of months of free rent. “We will ask those retailers specifically to put those dollars they saved to work in the form of marketing,” Thomas said. “People have to be able to find you.” Thomas and her colleagues don’t hesitate to speak up when they see a tenant that is about to make an unwise business decision. “We have had tenants who wanted to deviate from the norm and not put up a lit sign because it costs more money,” she said. “In addition to allowing them to use TI dollars to pay for that, we’ll explain to them why they need a lit sign: If somebody is driving by at night and you aren’t open, they may see your sign and say, ‘Oh, I didn’t know that store was there.’”

Larger landlords like Kimco have taken this kind of assistance to a new level in recent years, says Goodman. “With their KEYS [Kimco Entrepreneurs Year Start] program, they’re seeking entrepreneurs and new business owners and basically putting them in shopping centers, giving them a year of free rent and providing all kinds of support to make them successful,” he said. According to Kimco, the program has expanded into 19 states, with more than 600 KEYS small shops operating in the portfolio.

Landlords’ Image Problem

A great many of today’s successful chains got their start with store buildouts funded in whole or in part by landlords’ TI allowances. “It’s that way almost every time,” Hurwitz said. Nonetheless, landlords still have something of an image problem among tenants and the general public.

Tough negotiations in the COVID-19 era, in particular, have revealed the common misperception that landlords have carte blanche to give tenants free rent in perpetuity. “Many people don’t understand that landlords are answering to their lenders and that the big, publicly traded owners have to answer to their shareholders and meet certain goals,” Goodman noted. “The landlord is not just a king who can do whatever they want: ‘I like you, so I’m going to give you a break; I don’t like you, so I’m not.’ That’s not the way it works.”

While landlords are often portrayed as villains, adds Hurwitz, their TI lending and other activities create jobs, fund infrastructure, generate tax revenues and enhance people’s lives. “The shopping center industry and individual companies of size and magnitude need to do a better job of articulating the many benefits they bring to the communities they serve.”