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Question On Retail Ti's

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Gobears81

Senior Member
Joined
Nov 7, 2013
Professional Status
Certified General Appraiser
State
Illinois
Guys

This is more of a property management type of question, but still relevant in appraising-What types of rates are you seeing TI's amortized as part of the rents?

As an example, say that as-is rent is $5/ SF. A 10-year lease is proposed, and lets say that $50/ SF are spent on TIs, with the assumption that said $50/ SF will be depreciated by the end of the lease. Naturally, the rents aren't going to be $10/ SF ($5+$5/ SF) but something more. On a 12C calculator, I am inputting $50/ SF (in this example) on the white keys as PV, 0 for FV, 10 for n, and solving for payment. But I wasn't sure what rate to use for i. Or are you seeing property owners using another formula for determining the additional rents from said TIs?

Thanks
 

Meandering

Elite Member
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Feb 26, 2006
Professional Status
Real Estate Agent or Broker
State
Pennsylvania
Solve it backward with a pencil.

$0 = rent x (1 + rate) ^ years

Plug in the numbers you know and go from there.
 

Gobears81

Senior Member
Joined
Nov 7, 2013
Professional Status
Certified General Appraiser
State
Illinois
Solve it backward with a pencil.

$0 = rent x (1 + rate) ^ years

Plug in the numbers you know and go from there.
In the example I provided, that would reflect: $0= Y * 1+X^10, so I have two variables, what the resulting rents would be (Y) and the interest/amortization rate(X). This is a question that I'm asking appraisers what rates that they have seen, but with my appraisal hat off in this case.
 

Michael S

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Mar 18, 2009
Professional Status
Certified General Appraiser
State
New Mexico
I've seen TIs amortized at 6-8%. Nowadays with rates so low 6-7% is more common. I few years ago 7-8% was more common. Keep in mind that not all TIs will be amortized. I've seen cases where the landlord pays half out of pocket and then amortizes the other half. Typically if it's an expensive buildout like medical/dental office.

It's frustrating that a lot of leases I see don't spell out the tenant improvements as it's often negotiated separately in a work letter or it's done by an in-house contractor and it can be difficult to get the actual figures. However, sometimes I've come across leases that actually spelled it all out including the rate that they're amortized at.
 
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Gobears81

Senior Member
Joined
Nov 7, 2013
Professional Status
Certified General Appraiser
State
Illinois
I've seen TIs amortized at 6-8%. Nowadays with rates so low 6-7% is more common. I few years ago 7-8% was more common. Keep in mind that not all TIs will be amortized. I've seen cases where the landlord pays half our of pocket and then amortizes the other half. Typically if it's an expensive buildout like medical/dental office.

It's frustrating that a lot of leases I see don't spell out the tenant improvements as it's often negotiated separately in a work letter or it's done by an in-house contractor and it can be difficult to get the actual figures. However, sometimes I've come across leases that actually spelled it all out including the rate that they're amortized at.
Appreciate it. I was actually thinking 8%. Maybe that could be a starting point. I agree-it is unfortunate that more leases aren't more transparent about these types of thing
 

NachoPerito

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Jul 25, 2012
Professional Status
Certified General Appraiser
State
Washington
I am not sure on the consensus on this. It seems to me that nobody knows how long the improvements will last, 10 years, 15 years,... I usually assume 10 years because that is the lease length, but for medical office it could be up to 20 or 25 years. The length of time for the depreciation of the tenant improvements is a much bigger variable than deciding between 6% and 8% for the interest rate. I hardly see the tenant improvement payback stated in the lease, I usually just see a negotiated higher rate due to the allowance given. When making adjustments when comparing the lease to the subject I will sometimes just taking the TI allowance and divide by 10 (implying no interest on a 10 year payback).
 

Howard Klahr

Senior Member
Joined
Oct 4, 2004
Professional Status
Certified General Appraiser
State
Florida
I am not clear on specifically what you are looking for. Landlords set a rental rate for the space within their property. Inherent within that rental rate there is often an allowance for tenant improvements. Now that allowance unless set up to meet certain conditions established by the IRS for treatment as a "Qualified Lease", is treated as rental income for income tax purposes and is depreciated over 39 years as part of the book value basis of the property.

In the event the lease falls under the rules allowing it to be designated as a qualified lease, then the tenant improvements can be depreciated over the lease term up to 15 years for tax purposes. The lease term however is not just the base year but must include all renewal options within the lease agreement.

In terms of amortizing the tenant improvements by a landlord over the lease term in order to recoup the expenditure, this typically applies to expenditures above and beyond the allowance that is inherent in the renal rate to begin with. The discount rate use by the landlord is often based on their cost of funds which will vary depending on who owns the property and the type of investor (i.e. local or regional ownership vs institutional vs public company, etc).

The tax implications associated with federal income taxes will vary as well depending on how the property is held.
 

Gobears81

Senior Member
Joined
Nov 7, 2013
Professional Status
Certified General Appraiser
State
Illinois
I am not clear on specifically what you are looking for. Landlords set a rental rate for the space within their property. Inherent within that rental rate there is often an allowance for tenant improvements. Now that allowance unless set up to meet certain conditions established by the IRS for treatment as a "Qualified Lease", is treated as rental income for income tax purposes and is depreciated over 39 years as part of the book value basis of the property.

In the event the lease falls under the rules allowing it to be designated as a qualified lease, then the tenant improvements can be depreciated over the lease term up to 15 years for tax purposes. The lease term however is not just the base year but must include all renewal options within the lease agreement.

In terms of amortizing the tenant improvements by a landlord over the lease term in order to recoup the expenditure, this typically applies to expenditures above and beyond the allowance that is inherent in the renal rate to begin with. The discount rate use by the landlord is often based on their cost of funds which will vary depending on who owns the property and the type of investor (i.e. local or regional ownership vs institutional vs public company, etc).

The tax implications associated with federal income taxes will vary as well depending on how the property is held.
This is useful. I am helping a relative determine an appropriate rental rate on a property (not as an appraiser). There is an as-is rent, so any TIs would be over and above the base rent.
 
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DREA Dean

Sophomore Member
Joined
Apr 16, 2015
Professional Status
Certified General Appraiser
State
Pennsylvania
I've seen it spelled out in a few leases (mostly where some government agency is a tenant), and it's usually amortized over the 10-year initial lease period, even if the lease goes longer than that, or has additional option periods. The discount rate I've heard in recent years is around 8%, down from the 10% I heard for many, many years before. The problem with retail, of course, is strength of tenant. Will the tenant be paying rent long enough to pay off the TI? I usually don't see retail leases with any landlord-provided TI; the tenants pay for their own build-out.
 
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