Landlord concessions and tenant improvement allowances (TIAs) have been on the uptick over the last few years. Remote and hybrid work trends have led to higher competition for office tenants, and as a result, many landlords are offering longer periods of free rent and higher tenant improvement allowances. Some major markets, particularly New York City, are seeing more of this than others, but improvement allowances and concessions are up across the country. Negotiating these deals has become a critical part of the leasing process for landlords, who need to balance filling office space and keeping property cash flowing.
Tenant improvement allowances, also sometimes referred to as a fit-out or build-out allowance, are usually negotiated by landlords and tenants during a lease transaction. A credit is given to the tenant for improvements to the space leased and can go toward things like walling, flooring, HVAC, electrical costs, and plumbing. Things that may not be covered under a TIA could be things like furniture, electronics, and any moving costs. These allowances are often calculated based on an allowance per square foot, for example, a TIA could be calculated at $10 per rentable square foot, which in a 15,000-square-foot space, could mean a $150,000 allowance. TIAs aren’t expected to be returned to the landlord, but most landlords look to recoup the cost of the allowance by adding a portion of the TIA in the base rent or extending the length of the lease.
In Manhattan, the country’s largest office market and a city that’s often looked at as a barometer for the entire nation, flight-to-quality has been a much-talked-about trend. But while it’s true that office tenants are flocking to newer buildings with the most high-end amenities, they’re being given a lot of incentive to do so. Office tenants signing leases of at least 20,000 square feet and at least seven years at Class A buildings in Manhattan have been getting an average of 24 percent of their total rent as concessions, which includes free rent and TIAs, since 2020, according to Avison Young. “Quite frankly, I don’t see that number going down over the next several quarters,” said Avison Young’s Danny Mangru. Pre-pandemic, tenants in Manhattan’s office market received an average of 16.7 percent of their total rent as concessions, including free rent and TIAs, throughout their lease term. Trophy office tenants had the largest packages, at 17.2 percent of their total rent. Now, concession values have jumped across all building types, averaging 21.3 percent.
The sharp uptick in TIAs isn’t just limited to New York City. Higher figures are also being seen in major markets including Atlanta, Boston, Chicago, Los Angeles, San Francisco, and Washington, D.C., markets that all experienced jumps in TIAs and free rent periods since 2019, according to Avison Young data. While average TIAs were $128 per square foot in Manhattan between January and June of this year, figures were even higher in San Francisco and Washington, D.C., where TIAs averaged $135 per square foot in both cities. In Texas, many companies are choosing to sign longer leases in order to receive bigger TIAs. With steep construction costs continuing to stick around, agreeing to longer lease terms for a bigger TIA package makes sense for both landlords and tenants.
These latest numbers show an overall tenant-favorable office market that may continue for some time. “Three years now we’ve definitely seen a year-over-year decline in rents and a year-over-year increase in what tenants require,” said Chris Okada, CEO of New York City-based commercial real estate firm Okada & Co. “So playing the lowest rent on the block game really doesn’t separate you anymore, because everyone’s playing that game.” In New York, Okada has seen the size of TIAs quadruple since 2020, with averages going from about six months of free rent to the equivalent of almost two years of free rent. The high TIAs can vary widely not just by neighborhood, but even block by block, as his firm has seen. “I think it’s a, ‘this is what we know we can get’ scenario,” Okada said. Tenants that are paying top dollar in rent know they have a lot of options. “Why wouldn’t you do that?” he said. “They just want a good deal.”
But Okada isn’t worried about high TIAs. He sees the uptick in recent years as a cyclical occurrence that has historic precedence. “We’ve been here before,” he said, pointing to office occupancy reaching anywhere between 16 to 18 percent over the last few decades during economic downturns, from the time period of the Great Recession, the dot-com bubble in the late 90s, after 9/11, and in the early 1990s. “People in business for more than 20 years have seen this before numerous times and know rents can recover quickly and double,” Okada said. He also isn’t worried about the state of the office going forward, given the significant shift to remote and hybrid work. “There’s always a new wave of space users that come in and take up more square footage, it happens every single economic cycle,” he said. “Maybe it will be AI companies next?” That prediction could very well turn out to be true. After all, AI companies looking to lease space in the beleaguered San Francisco office market have been a beacon of hope for the city’s real estate industry.
In today’s office environment, tenants tend to have a lot more options to choose from and a lot of incentives to sign a lease. TIAs and rent concessions are on the rise in major markets around the country, and while getting free rent and a hefty sum to build out a space is definitely favorable to an office tenant, by getting a longer lease term in exchange, landlords can have the assurance of cash flow for their property. Higher TIAs and rent concessions are expected to continue for the foreseeable future by many in the industry, especially as office occupancy has been slow to improve over the last several months. But as history has shown, burgeoning industries that are less impacted by economic conditions, like the AI industry, could help turn office markets around and turn the tide on higher TIAs and concessions.