In a commercial lease, who pays for tenant improvements is a matter of negotiation, not a fixed rule: the landlord, the tenant, or both can fund the build-out, and the split falls into one of four structures. In a turnkey deal the landlord pays for everything and recovers the cost through higher rent. With a tenant improvement allowance, the landlord contributes a fixed dollar amount and the tenant covers any overage. In an as-is lease the tenant funds the entire project. Under a rent abatement arrangement the tenant pays upfront and recovers the money through months of free rent. Which structure you end up with depends on what you negotiate, and the details live in a document called the work letter.
The Work Letter Controls the Money
The work letter is an exhibit attached to the lease that spells out the scope of construction, who hires the contractors, how payments are released, what happens if costs exceed the budget, and the timeline for completion. It is the construction contract hiding inside the lease, and it carries equal legal weight.
A well-drafted work letter covers the division of labor between landlord and tenant, the approval process for architectural plans and change orders, eligible expenses for any improvement allowance, and the triggers that start the rent clock. If any of these points are vague, disputes follow. Tenants who gloss over the work letter because it looks technical are making one of the most expensive mistakes in commercial real estate.
Turnkey: The Landlord Pays, You Repay Through Rent
In a turnkey deal the landlord pays for and manages the entire build-out before the tenant moves in. The landlord picks the contractors, approves the materials, and delivers a finished space that matches an agreed-upon set of specifications. The tenant walks in without writing a check to a contractor.
That does not mean the tenant avoids paying. Landlords recapture construction costs by building them into the base rent over the lease term. A space that might otherwise lease for $25 per square foot could jump to $30 or more once the landlord factors in the amortized construction debt. Over a seven- or ten-year lease the tenant effectively finances the build-out through higher monthly payments. This model works best for tenants who want cost certainty and minimal project management, but they pay a premium for that convenience.
The real risk is late delivery. If the landlord’s contractors fall behind, the tenant loses weeks of revenue waiting for a space that was supposed to be ready on day one. Strong leases include delay remedies: a day-for-day rent credit for each day construction runs past the agreed completion date, with escalating penalties if the delay stretches beyond 30 or 60 days. Some leases give the tenant the right to terminate if the delay passes a set threshold, typically around 60 to 90 days. Tenants who skip this protection have no leverage when a project stalls.
Tenant Improvement Allowance: The Most Common Split
A tenant improvement (TI) allowance is the most common arrangement. The landlord contributes a fixed dollar amount toward construction, calculated on a per-square-foot basis. For a 3,000-square-foot space with a $50 per square foot allowance, the landlord’s contribution caps at $150,000. Anything above that comes out of the tenant’s pocket.
TI allowances typically cover only hard construction costs: framing, drywall, flooring, electrical work, plumbing, and HVAC installation. Soft costs like architectural fees, engineering, permit applications, and legal review usually fall outside the allowance unless the work letter specifically includes them. Soft costs can run 15 to 25 percent of the total project budget. If the lease is silent on soft costs, assume the tenant pays them.
How the Money Actually Flows
Most landlords do not hand over a lump sum on signing day. Instead, they require the tenant to submit paid invoices and lien waivers from contractors before releasing funds. Some leases use progress payments tied to construction milestones, releasing a portion of the allowance after framing, another after rough-in electrical and plumbing, and the balance after final inspection. This drip-feed approach protects the landlord but forces the tenant to carry the cash flow gap between paying contractors and receiving reimbursement.
If the tenant cannot produce proper documentation or violates any term in the work letter, the landlord can withhold the remaining allowance. Sloppy recordkeeping kills more TI reimbursement claims than bad construction does.
What Happens to Unused Allowance
When construction comes in under budget, the leftover allowance does not automatically go back to the tenant. Many landlords write the lease so they keep any surplus. Tenants should negotiate for unused dollars to be credited against rent; letting the landlord pocket the savings defeats the purpose of negotiating a higher allowance in the first place.
As-Is: The Tenant Pays for Everything
In an as-is lease the tenant takes the space in its current condition and pays for every dollar of construction. This happens most often when a business has highly specialized needs, like a dental office requiring plumbing at every operatory station or a restaurant needing commercial kitchen ventilation. These improvements rarely increase the space’s value for a future tenant, so landlords have little incentive to contribute.
Even when the tenant funds the entire project, the landlord retains approval rights over architectural plans, contractor selection, and permits. The landlord is protecting the building’s structural integrity and ensuring the work meets code. The tenant also bears all permitting fees, which vary widely by jurisdiction and project scope.
The ADA Path-of-Travel Trap
Tenants funding their own build-outs often get blindsided by accessibility requirements. Under federal regulations, when an alteration affects a primary function area, the path of travel to that area must also be made accessible, including entrances, routes, restrooms, and drinking fountains. The obligation is capped: accessibility upgrades are considered disproportionate when they exceed 20 percent of the total cost of the alteration to the primary function area.1eCFR. 28 CFR 36.403 – Alterations: Path of Travel But 20 percent of a $200,000 renovation is still $40,000 in unplanned accessibility work. The 2010 ADA Standards for Accessible Design set the minimum technical requirements for all commercial alterations.2ADA.gov. 2010 ADA Standards for Accessible Design
Who pays for ADA compliance is a negotiation point, not a settled rule. If the lease is silent, the tenant making the alteration typically bears the cost. Savvy tenants push for a lease clause allocating path-of-travel upgrades to the landlord, since those improvements benefit the building long after the tenant leaves.
Rent Abatement: You Pay, Then Recover Through Free Rent
Rent abatement is a hybrid. The tenant funds the construction out of pocket, and the landlord compensates by waiving rent for a set number of months. A tenant who spends $100,000 on renovations might receive ten months of free rent at $10,000 per month. The economics look similar to a TI allowance, but the cash flow works differently: the tenant needs enough liquidity to pay contractors upfront and then recovers the money over time.
The lease ties the abatement period to a specific rent commencement date. Full rent kicks in on that date whether or not construction is finished, so delays cost the tenant twice: once in extended construction expenses and again in rent on an unusable space. Most abatement clauses also require a certificate of occupancy before the credit applies. If the tenant defaults or terminates early, the landlord can claw back the unamortized portion. A tenant who received $100,000 in rent abatement on a ten-year lease and walks away after three years could owe $70,000.
Who Really Owns What You Build
Here is the part that surprises people: almost everything a tenant builds into a commercial space becomes the landlord’s property when the lease ends. Walls, flooring, built-in cabinetry, plumbing, HVAC systems, and electrical upgrades all stay with the building. The legal concept is reversion, and it applies regardless of who paid for the work.
The exception is trade fixtures: business-specific items that are attached to the space but can be removed without significant structural damage. Restaurant booths bolted to the floor, display shelving, salon chairs, and specialized equipment mounts generally qualify. A tenant can remove trade fixtures at lease end as long as three conditions are met: the tenant paid for them, removing them would not cause expensive damage, and they have not become an integral part of the structure.
Restoration Clauses Can Reverse the Math
Many leases require the tenant to remove certain improvements and restore the space to its original condition before handing back the keys. Tearing out a custom build-out sometimes costs nearly as much as installing it. The landlord might want walls removed, the ceiling grid replaced, or specialty flooring ripped out so the space can be re-leased to a different type of tenant.
Restoration obligations should be negotiated at the start of the lease, not discovered at the end. Get the landlord to specify in the work letter exactly which improvements must be removed and which can stay. Without that clarity, the landlord holds all the cards at surrender.
Two Risks to Price In Before You Sign
Whoever pays, two issues can turn a clean build-out into a legal or tax problem. The first is mechanic’s liens. When a tenant hires contractors and those contractors do not get paid, the unpaid contractor can file a lien. Depending on the jurisdiction and the landlord’s level of involvement, that lien can attach to the landlord’s property, not just the tenant’s leasehold interest. The lien waiver requirement built into TI reimbursement exists for this reason: landlords require lien waivers from every contractor and subcontractor before releasing funds, so each payment extinguishes the contractor’s lien rights for the completed work.
The second is tax treatment of the allowance. Under Section 110 of the Internal Revenue Code, a TI allowance paid by a landlord to a tenant is excluded from the tenant’s gross income if three conditions are met: the lease is for retail space, the lease term is 15 years or less, and the allowance is spent on qualified long-term real property used in the tenant’s business.3Office of the Law Revision Counsel. 26 U.S. Code 110 – Qualified Lessee Construction Allowances for Short-Term Leases The exclusion only applies to the extent the tenant actually spends the money on qualifying improvements. Any portion the tenant receives but does not spend on qualified real property gets included in gross income.4IRS.gov. Revenue Ruling 2001-20 – Section 110 Qualified Lessee Construction Allowances The lease must also expressly state that the allowance is for constructing or improving the property; if that language is missing, the safe harbor falls apart. Office, warehouse, and medical tenants in non-retail space may not qualify at all. Any tenant receiving a significant TI allowance should confirm the tax treatment with a CPA before signing.