Should You Put Your Tenant Improvement Allowance in Escrow?

In this article, you'll learn:

• The benefits of placing your Tenant Improvement Allowance (TIA) in escrow.
• How escrow accounts protect tenants and ensure proper use of funds.
• Current trends in office market pressures and rising TIA offers.

Negotiating the Tenant Improvement Allowance (TIA) was already one of the most critical aspects of lease negotiation. Now, let’s throw in the uncertainty that your landlord may not be able to provide what they promise, and prepare for things to get dicey.

Amidst an oversaturated office market, landlords are feeling the pressure to offer generous concessions to attract tenants. And at the same time, the demand for premium properties is skyrocketing compared to the performance of B and C class offices.

All this culminates in the fact that landlords are offering higher TIA's than ever, but if you don’t implement protections before signing your lease, your finances may be in jeopardy. Learn about why tenants should consider putting their TIA's in an escrow account and what happened that led to this.

Putting TIA into Escrow

Putting a tenant improvement allowance in an escrow account involves depositing the allocated funds into a separate account held by a neutral third party, typically an escrow agent or a financial institution. The purpose of this arrangement is to safeguard the funds and ensure they are used appropriately for the approved tenant improvements.

When the tenant improvement allowance is placed in an escrow account, the landlord does not have direct access to these funds. Instead, the tenant and landlord agree on the conditions and terms under which the funds can be disbursed for approved construction or renovation activities.

The escrow agent acts as a custodian of the funds, releasing them based on the agreed-upon milestones or completion of the tenant improvements. This escrow arrangement provides a level of protection for both the tenant and the landlord.

The tenant has assurance that the funds will be available for the intended improvements, while the landlord has confidence that the funds are secure and will be used appropriately.

By utilizing an escrow account for the tenant improvement allowance, potential disputes and risks related to the allocation and use of the funds are minimized. It provides transparency, accountability, and a structured process for managing and utilizing the funds, ensuring that the tenant improvements are completed as intended.

TIA in Escrow Provides Protections for Tenants

Office tenants can protect their investment, maintain project continuity and control over their office space's design and functionality. This approach provides tenants with peace of mind and greater assurance that their workspace will meet their specific requirements, even in challenging landlord situations.

Prospective office tenants now should absolutely be considering putting this into action. With landlords defaulting left and right, the leasing environment has become precarious for the tenant. And if there’s no safeguards in place in the lease before it happens, the financial burden gets put entirely on tenants. As always, be sure that you're working hand-in-hand with an accredited commercial real estate attorney for all things legal. 

Oversaturated Office Market Driving Up Tenant Improvements

The modern tenant has different worries. Instead of prioritizing location or amenities, tenants have more foundational concerns whether their landlord’s financials are on the line and whether hard times will negatively impact the service and upkeep of their building. 

Because with so much cheap, empty space on the market post-WFH movement, most buildings have seen their profit margins shrink or go into the red because the deals they offer must be incredibly competitive to lure in long-term tenants.

Unfortunately for landlords, this cycle has pushed many past their breaking point. Because even if they find that perfect, credit-worthy tenant, they should be prepared to shell out a hefty tenant improvement allowance and lure them in with a low base rent. And this is an observable trend across the nation.

But what happens when they promise too much for too many tenants? Well, the receiver may have to step in and under new management you may find that those promised tenant improvement dollars were lost to the wayside. This is just one of the ways tenants can be financially implicated by a landlord’s default… Learn the other methods to safeguard your tenancy against landlord defaults. 

So new tenants can act before they lose out on any promised funds and negotiate for an escrow account. This is especially critical because the tenant improvements have been getting bigger than ever.

Can Landlords Fulfill Skyrocketing TIA Promises?

Landlords have been promising more than ever when it comes to TIAs. Some have even gone so far as to cover soft costs like furnishing and architectural costs which used to be out of the question. But because of the density of vacancies and dropping occupancies landlords are putting more on the line to draw in interest.

Now compound this with the fact that the role of the office has evolved. It is no longer a must-visit for a captive audience. With the option of WFH, To remain competitive in the talent war, businesses are now being urged to consider how they can make their offices more welcoming. Because there has been a great cultural shift. If employees are expected to visit the office, they are expecting to be wooed. It should offer something that people can’t get from home and makes the commute worthwhile. The experience should be more akin to a hospitality service than a hamster wheel for the rat race.

So, the average tenant now likely has higher standards when it comes to presentation and layout. New safety measures and premium features are absolutely necessary for modern offices. And if landlords can’t promise this, tenants will turn their attention elsewhere.

All this culminates in the fact that landlords are feeling a lot of pressure to offer whopping TIAs. This is especially true for landlords of older buildings. As the standard for office building elevates in conjunction with rapid technological evolution, more renovations will be demanded. It also means that the drastic divide in property valuations between Class A and B properties will continue- and so will the financial picture of the landlords of both.

So, if you’re signing a new lease, you want to ensure that they can fulfill what they promise. Again, this is more critical for tenants of older buildings. Make sure that you don’t get stuck in a deteriorating or outdated building if a landlord can’t afford to accommodate the cost of renovations.

If you don’t outline safeguards in your leases now regarding any tenant improvement allowances, the financial burden for their properties will fall entirely on your head. And at this point, this is a likely  problem for tenants. Putting your TIA into escrow accounts is a real solution to a potential nightmare.

What Tenants Should Know

The trend of offering generous tenant improvement allowances is occurring alongside a rise in large-scale landlord defaults.

As some landlords struggle to meet their financial obligations, tenants need to approach lease agreements with caution. It's important for tenants to conduct thorough due diligence, carefully review lease terms, and negotiate favorable clauses that protect their interests in the event of landlord defaults.

Putting tenant improvement dollars in an escrow account is a powerful and actionable step tenants can take to safeguard their interests in this uncharted environment. To learn other methods that can save you millions over a lease term and also stay on top of the latest CRE trends, subscribe to our blog.