In commercial real estate, TI stands for tenant improvements: the permanent interior changes a landlord or tenant makes so a rental space fits a particular business. The work can be as light as new paint and partition walls or as heavy as a full build-out of a bare shell, and it is usually funded through a negotiated tenant improvement allowance (TIA) governed by a work letter attached to the lease. Getting the TI terms right before signing is one of the highest-leverage things a commercial tenant can do, because the same deal can look generous or expensive depending on how the allowance, the build-out responsibilities, and the exit terms are written.
What Counts as a Tenant Improvement
Tenant improvements are permanent changes to the interior of a commercial space: partition walls to create offices, flooring, ceiling grids, lighting, plumbing and electrical upgrades. Because these modifications become part of the building, they typically remain the landlord’s property when the lease ends.
Trade fixtures are a different category. These are items a business installs for its own operations, such as display cases, signage, or specialized equipment, and the tenant can usually remove them at lease-end as long as the removal does not damage the property. The line between the two matters at move-out, so it is worth clarifying in writing which items will stay and which will go.
How much work a space needs depends on where it starts. A first-generation or “grey shell” space has bare walls, no HVAC system, and minimal finishes, requiring a ground-up interior build-out. A second-generation space already has offices, restrooms, and climate control from a previous tenant, and may need only cosmetic updates or minor reconfiguration. The gap in cost between the two is often large, and it drives how much allowance a tenant should push for.
How the Tenant Improvement Allowance Works
The TIA is a dollar amount the landlord agrees to contribute toward the build-out, expressed per rentable square foot. Figures typically fall somewhere between about $10 and $100 per square foot, depending on property type, local market conditions, and the complexity of the work. A simple retail refresh sits at the low end; a full office build-out or medical suite conversion can run well above $50 per square foot.
Several things push the number up or down. Longer lease terms justify larger allowances, because the landlord has more years of rent to recover the investment. Strong tenant financials and good credit reduce the landlord’s risk and support a higher offer. In a soft market with high vacancy, landlords compete for tenants partly by sweetening the TI package.
One point catches many first-time commercial tenants off guard: the allowance is not free money. Landlords typically recover the cost by building it into base rent over the lease term, often with an implied interest rate. A $50-per-square-foot allowance on a 10,000-square-foot space is $500,000 the landlord needs to recoup. If you compare two otherwise identical spaces, one offering a large TIA with higher rent and one offering a smaller TIA with lower rent, the total cost over the life of the lease may be similar. Run the all-in occupancy cost before assuming the bigger allowance is the better deal.
Hard Costs, Soft Costs, and Overages
TI allowances generally cover two categories. Hard costs are the physical construction expenses: demolition, framing, drywall, flooring, electrical, plumbing, and HVAC. Soft costs are the supporting expenses: architectural and engineering fees, permit applications, and project management. Not every landlord agrees to apply the allowance to soft costs, so confirm which categories are covered before signing.
If actual costs exceed the allowance, the tenant pays the difference. Overages typically must be paid directly to the contractor or reimbursed to the landlord before the tenant takes possession. Get detailed construction bids before finalizing the allowance amount, not after.
What the Work Letter Should Pin Down
The work letter is a legal document, usually attached to the lease as an exhibit, that governs the build-out. Treat it as the construction contract embedded in your lease. A workable work letter includes detailed plans and specifications, a line-item budget, a schedule for plan submission and approval, and construction milestones. Nailing these down early prevents the most common commercial lease dispute: a disagreement about what was promised, what it costs, and when it will be done.
Two work-letter details deserve particular attention. First, the “building standard” finishes: the default materials used throughout the property, such as a specific ceiling tile, paint grade, carpet, or door hardware. If you want anything above standard, say hardwood floors instead of carpet or glass office fronts instead of drywall, the upgrade typically comes out of your pocket or eats into the remaining allowance. Second, delay provisions. Many work letters include a liquidated damages clause setting a pre-agreed daily cost when the project misses substantial completion, and delays caused by the landlord’s contractors may trigger free rent credits for the tenant. Read carefully how delay risk is allocated.
Landlord-Build vs. Tenant-Build
Build-outs follow one of two models, and the choice affects cost, control, and risk.
- Landlord-build. The landlord hires the contractors, manages the project, and pulls the permits. The tenant has less day-to-day control and less burden. Landlords commonly charge a construction management fee, often in the range of 5 to 15 percent of total project costs, drawn from the allowance or billed separately.
- Tenant-build. The tenant hires its own licensed contractors and manages the project. This gives more control over scheduling, subcontractor selection, and cost, but the tenant also carries more risk if something goes wrong. The landlord typically retains approval rights over plans, contractors, and materials.
Either way, building permits must be issued based on approved plans before demolition or construction begins. Permit fees vary widely by jurisdiction and often run between 1 and 3 percent of total construction value. The work letter should also specify insurance requirements during construction: at minimum, commercial general liability for the general contractor, and often a builder’s risk policy covering fire, weather, and other hazards to the work in progress.
Legal Exposure to Watch For
ADA Compliance
Under Title III of the Americans with Disabilities Act, both landlord and tenant can be held liable for accessibility violations in a commercial space. A lease can allocate specific ADA responsibilities between the parties, but it cannot eliminate either party’s underlying federal obligation. As a general matter, the landlord handles accessibility in common areas and the tenant handles accessibility within its own space.1ADA.gov. Americans with Disabilities Act Title III Regulations
When a build-out alters an area where the main business activities take place, the accessible path of travel to that area, along with restrooms, telephones, and drinking fountains serving it, must also be brought into compliance. If path-of-travel improvements would cost more than 20 percent of the total alteration cost, the obligation is capped at that 20 percent threshold. A tenant’s alterations within its own space do not, on their own, trigger a path-of-travel obligation for the landlord in separately controlled areas.2eCFR. 28 CFR 36.403 – Alterations: Path of Travel
Mechanic’s Liens
Unpaid contractors or subcontractors on a build-out may have the right to file a mechanic’s lien against the property, even when the landlord had no role in hiring them. In many jurisdictions, tenant improvements are presumed to have the owner’s consent unless the owner takes specific steps to disclaim responsibility, such as recording a notice of non-responsibility. Without that protection, an unpaid subcontractor’s lien can attach to the landlord’s title.
Lien waivers are the primary defense. These are signed releases of lien rights in exchange for payment, and they come in four standard forms: conditional or unconditional, and tied to either a progress payment or the final payment. Most work letters require the party running construction to collect waivers from every contractor and subcontractor before releasing each payment. Paying the general contractor is not enough on its own; subcontractors and material suppliers can lien the property too, so waivers need to come from every link in the payment chain.
When Rent Actually Starts
The build-out ends in stages, not all at once. “Substantial completion” is the point at which the space is finished enough to be used for its intended purpose, even if minor punch-list items remain, such as a scuffed wall, a missing outlet cover, or a sticky door. Local authorities then inspect the space and, if it passes, issue a certificate of occupancy.
Rent commencement is almost always tied to substantial completion, not to the certificate of occupancy and not to the start of construction. This matters because the tenant typically does not owe rent during the build-out. Many leases also include a rent abatement period, often a few months of free or reduced rent after substantial completion, so the tenant has time to move in, install equipment, and open. Make sure the lease defines clearly when rent starts, what triggers it, and how construction delays affect the timeline.
If You Leave Early: Clawback Provisions
Most commercial leases let the landlord recover the unamortized portion of the TI allowance if the tenant leaves before the lease ends. The usual method is straight-line amortization: the total allowance is divided evenly across the months of the lease, and the balance remaining at the point of early termination becomes due, often with interest.
So, on a $200,000 allowance over a 10-year lease, a tenant who defaults after year 4 could owe the remaining 60 percent, or $120,000, plus any contractual interest, as additional rent. Some landlords apply the same amortization treatment to any rent abatement given at the front of the lease. Before signing, negotiate the interest rate, whether the clawback steps down over time, and precisely which events trigger repayment.
Tax Treatment of Tenant Improvements
Section 110 Exclusion for Retail Tenants
Under federal tax law, a construction allowance from a landlord to a retail tenant may be excluded from the tenant’s gross income if specific conditions are met. The lease must be a short-term lease of retail space, defined as 15 years or less, and the allowance must be used for qualified long-term real property that reverts to the landlord when the lease ends. The exclusion applies only up to the amount the tenant actually spends on qualifying construction.3Office of the Law Revision Counsel. 26 USC 110 – Qualified Lessee Construction Allowances for Short-Term Leases
Two limits narrow this benefit. “Retail space” means property used to sell goods or services directly to the public, so office tenants and warehouse tenants do not qualify. And both landlord and tenant must report the allowance to the IRS, which makes documentation essential.3Office of the Law Revision Counsel. 26 USC 110 – Qualified Lessee Construction Allowances for Short-Term Leases
Depreciation of Tenant-Paid Improvements
When a tenant pays for improvements out of pocket, whether covering overages or funding the whole build-out, those costs may qualify as “qualified improvement property” for depreciation. Qualified improvement property is any improvement to the interior of an existing nonresidential building, excluding building enlargements, elevators, escalators, and changes to the internal structural framework.4Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System
Qualified improvement property carries a 15-year recovery period under MACRS. As of 2025, federal legislation restored 100 percent bonus depreciation for qualified improvement property with no scheduled phase-down, allowing a tenant to deduct the full cost of eligible improvements in the year they are placed in service. Rules in this area have shifted repeatedly, so confirm the current treatment with a tax professional before relying on bonus depreciation for a specific project.
Who Maintains the Improvements Later
Once construction is done, someone has to maintain what was installed. The default in most commercial leases is that the tenant handles non-structural upkeep inside its space, such as cleaning, carpet replacement, lighting repairs, and minor fixtures, while the landlord handles structural elements and major systems like the roof, foundation, HVAC equipment, and main electrical and plumbing. That split is negotiable, and leases often shift system maintenance to the tenant, especially in single-tenant buildings and triple-net (NNN) leases.
Review the maintenance provisions before the build-out, not after. If the landlord installs a specialized HVAC system during construction, pin down in writing who pays for upkeep and eventual replacement. Ambiguity about maintenance is one of the most common sources of landlord-tenant disputes over the life of a commercial lease.