What Is Tenant Improvement?
Tenant improvement (TI) refers to modifications made to a rental space for a specific tenant — partitions, flooring, lighting, HVAC adjustments, custom millwork. In commercial real estate, landlords often provide a TI allowance ($10–$60/sqft) as an incentive to sign a lease. The allowance is amortized over the lease term. In residential, TI is less common but applies to custom finishes, built-ins, or lease option scenarios where the tenant pays for improvements. Depreciation runs 15 years for qualified improvement property or 39 years for non-residential real property.
Tenant improvement (TI) is the buildout or modification of a rental space to meet a specific tenant's needs — from walls and flooring to custom fixtures — typically negotiated as a landlord-funded allowance ($10–$60/sqft in commercial) in exchange for a longer lease term, with depreciation over 15 or 39 years depending on the improvement type.
At a Glance
- What it is: Modifications to a rental space for a specific tenant — buildout, finishes, fixtures
- Why it matters: TI allowances are a key lease negotiation lever; who pays affects NOI and capex
- Commercial range: $10–$60/sqft TI allowance typical; varies by market and tenant credit
- Lease relationship: Longer lease = more TI; 5-year lease might get $25–$40/sqft; 10-year gets more
- Tax treatment: 15-year depreciation for qualified improvement property; 39-year for structural components
How It Works
What counts as TI. Partition walls, flooring, ceiling tiles, lighting, electrical and data outlets, HVAC modifications, millwork, custom cabinetry, paint, and finishes. In commercial, "vanilla shell" delivery means the landlord provides raw space — tenant pays for or receives an allowance toward buildout. "Turnkey" means the landlord builds to tenant specs. The line between landlord capex and TI allowance can blur — both hit the landlord's balance sheet, but TI is negotiated as a lease incentive.
TI allowance. The landlord agrees to spend up to $X per square foot on tenant buildout. $25/sqft on a 3,000 sqft space = $75,000. The tenant may use it for design, permits, and construction. Unused allowance typically reverts to the landlord. The allowance is amortized over the lease term — so a $75,000 TI on a 5-year lease adds $15,000/year to the landlord's cost. That reduces effective NOI during the amortization period.
Lease term relationship. Longer leases justify larger TI allowances. A 3-year lease might get $15–$20/sqft. A 5-year lease: $25–$40/sqft. A 10-year lease: $40–$60/sqft or more for strong credit tenants. The math: TI cost ÷ lease term = annual amortization. You want the rent to cover that plus operating expenses and a return.
Who pays. Landlord-funded TI is common in commercial. Tenant-funded TI happens when the tenant wants custom buildout beyond the allowance — they pay the overage. In triple-net lease deals, the tenant often pays for their own buildout; the landlord delivers a shell. In residential, TI is rarer — tenants usually accept the space as-is. Lease option deals sometimes include tenant-funded improvements that convert to equity or rent credit.
Depreciation and amortization. For tax purposes, TI is depreciated. Qualified improvement property (QIP) — interior, non-structural improvements to non-residential property — gets 15-year depreciation. Structural components may be 39-year. Amortization for lease accounting is separate — the TI cost is expensed over the lease term for GAAP/income statement purposes.
Real-World Example
Retail space in Charlotte, NC. A landlord has a 2,500 sqft retail shell. A dental practice wants to lease it for 5 years. Market rent: $28/sqft NNN. The tenant requests $35/sqft in TI — custom plumbing for operatories, cabinetry, flooring, and branding.
The landlord counters: $30/sqft TI allowance ($75,000 total) for a 5-year lease at $28/sqft, with two 5-year options at 3% bumps. The tenant accepts. The landlord amortizes $75,000 over 60 months = $1,250/month. Rent: $2,500/month (2,500 × $28 ÷ 12). NNN pass-throughs cover taxes, insurance, and operating expenses. The landlord's effective rent after TI amortization: $2,500 − $1,250 = $1,250/month for the first 5 years — but they've locked in a 5-year tenant with renewal options. The capex spend is $75,000; the tenant's buildout cost is covered. At renewal, the TI is fully amortized — the landlord keeps full rent.
Pros & Cons
- Attracts tenants who need custom space — dental, medical, restaurant, office
- Longer lease terms in exchange for TI — reduces vacancy-rate risk
- Amortization spreads cost over lease term — matches expense to revenue
- Value-add potential — improved space may support higher rent at renewal
- Depreciation provides tax benefit — 15-year for QIP
- Upfront capex — $25–$60/sqft can be $50K–$200K+ per tenant
- Tenant-specific buildout may not suit next tenant — demo cost at turnover
- Over-improvement risk — custom buildout that doesn't add proportional rent
- Amortization reduces effective NOI during the lease term
- Tenant default leaves landlord with custom space and unpaid TI
Watch Out
- Compliance risk: TI work may require permits and building codes compliance. Unpermitted work can create liability.
- Modeling risk: Underestimate TI cost and your returns suffer. Get contractor quotes before signing. Build 10–15% contingency.
- Execution risk: Tenant-directed buildout can run over budget. Cap the allowance; require tenant to pay overages. Define "substantial completion" in the lease.
- Exit risk: Over-customized space limits the next tenant pool. Neutral buildout has better re-leasing potential than tenant-specific design.
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The Takeaway
Tenant improvement is the buildout or modification of a rental space for a specific tenant. In commercial, landlords often provide a TI allowance ($10–$60/sqft) in exchange for longer leases. Amortize the cost over the lease term. In residential, TI is less common but applies to lease option and custom scenarios. Depreciation runs 15 or 39 years. Negotiate TI as a lever — more TI for longer term, cap overages, and avoid over-customization that hurts re-leasing.