When you have to lease a space, you make structural changes to it and make it apposite for the business needs. These processes of structural changes are called leasehold improvements. Some examples of leasehold improvements are changes in light settings, the reception area, dressing room, offices, and other rooms. To improve a building, you need to do partitions and carpet/flooring, paint, etc. might be required.
The payment for these improvements is often paid by the property owner in advance (sometimes the owner of the property includes it in the monthly rent) or the tenant might do certain changes on their own and save some money. If you are a general contractor or a part of any construction management company, you might be well-aware of leasehold improvements. If you are not aware of it, this article will provide you the basic knowledge about leasehold improvements.
What are common leasehold improvements?
Commonly, leasehold improvements include partitioning of open, large space into smaller and more structured areas. The most common leasehold improvements are the installation of reception counters or retail shelving, floor replacement, specialized or additional lighting, and enhanced technology systems. Some specific or custom leasehold improvements are found in particular industries, like retail, but every leasehold improvement is according to the tenant because the rationale of such changes is to transform the leased space into a more usable one.
The objective of leasehold improvements
Leasehold improvements are usually performed by commercial general contractors to retain the tenant, attract some specific kind of business, or are offered as a part of the fresh lease negotiation. The major objective of leasehold improvements is to provide customized alterations that a commercial tenant or the property owner wants in the leased space. These alterations are aimed to benefit the tenant and almost all the improvements favor the tenant’s operational needs and preferences.
Leasehold Improvements vs. Tenant Improvements vs. Buildout
Tenant improvements and buildouts are just the synonyms of leasehold improvements. It depends upon the industry whose name it uses for the same process. In general, all three terms signify work that is done in a building or office to make it suitable for the new tenant’s requirements.
The term “tenant improvements” or TI is commonly used in the commercial construction world. When it is seen from the viewpoint of accounting, it is called “leasehold improvements” and when it is seen from the viewpoint of construction, it is called “buildout.” Different professions use different terms, such as construction companies, commercial realtors or leasing companies use the term buildout or tenant improvements, while accountants use the term leasehold improvements.
Leasehold Improvements vs. Building Improvements
A minor difference is there between leasehold improvements and building improvements. A leasehold improvement is carried out within the rented space’s walls. A leasehold improvement is to provide benefits to a tenant and a building developed on the leased land also falls into the category of leasehold improvements.
A building improvement is carried out outside your space. For example, when the property owner installs a storeroom inside the office space, it is a kind of leasehold improvement. If the storeroom on the floor occupied by two different tenants needs to be renovated, this will fall into the category of building renovation. The reason behind it is that the benefits that will be shared between the tenants and the improvements are usually owned by the property owner for a short period of time as well as after the lease expiration.
New vs. Existing Space
Someone new is often confused about whether to go for a new space or an existing one. The new spaces require frequent leasehold improvements. If the condition of the space leased is “cold, dark shell”, it will be missing air conditioning or heating ducts, ceiling or lighting grids, and floor coverings.
Conversely, an existing space can be a better fit. The already configured commercial space could be according to the requirements of a tenant or very near to fulfill all the requirements. This factor should always be kept in mind and existing space is often less expensive when improvised in comparison to building out totally new space.
When a lease is signed, there are various negotiating points and one of them is the cost of lease improvements. While negotiating, it is decided who will pay for the leasehold improvements. Either the property owners promise to pay the money for leasehold improvements or the tenant promises to pay. There are some cases when the property owner promises a fixed amount and whatever cost will come above that amount, it will be paid by the tenant. In short, the answer to who will pay for the leasehold improvements completely depends upon the mutual understanding of the tenant and property owner.
Accounting of Leasehold Improvements
Leasehold improvements are the assets of the business because these improvements are attached to the real property. They might be depreciated and the information of leasehold improvements’ cost should be kept for the tax advisor.
From the accounting perspective, the work carried out in a building, as well as the fixtures which are put in the property (plumbing and lights, for example), are regarded as assets of the business, because the business owner pays for them. These should be depreciated and treated in a way similar to other assets. The only difference is that these assets can be sold without selling the building.
The Issue Leasehold Improvements Have
A common mistake made by novel business owners is that they spend too much money on leasehold improvements. If you are also a new business owner, don’t put much money in the leasehold improvements of leased commercial space. The changes done won’t go with you and it is not sure that the other person renting that space will require the same things as you required.
The commercial property tenants should always remember that to carry out leasehold improvements, they should first get the property owner’s explicit permission. All the details in the leasehold improvement project need to be in writing and agreed upon by both parties in advance. This will avoid any misunderstandings or unpleasant surprises and the outcome will be as per the expectations.