Two Win-Win Strategies For Financing Commercial Tenant Improvements
Business owners who are thinking of renting or buying commercial property typically consider making changes to the space, including:
- general renovations
- façade enhancements
- installation of furniture, fixtures, and equipment
- Americans with Disabilities Act (ADA) compliance improvements
The space modifications outlined above are all common types of tenant improvements. And once they are complete, a business can move into the building and begin operating. However, until they are done, a business cannot take occupancy of the space. One of the biggest challenges that impact an entrepreneur’s ability to build out commercial space (i.e., retail, office, industrial, etc.) is — you guessed it — financing.
Tenant improvements are big ticket expenses that require significant capital investment. Whether the property owner or the tenant pays for those expenses is often the subject of much debate. There is no right or wrong answer on this issue. In the end, if the lease/purchase contract is structured well, investments in tenant improvements pay for themselves.
The following are two “win-win” strategies for financing commercial tenant improvements:
1) Raise the Rent – Landlords are in a great position to get loans from banks, non-bank SBA lenders, non-bank commercial real estate financing companies, and alternative lenders to fund construction improvements for prospective/existing tenants. For more information on real estate financing options, please see my article “The Five Kinds of Commercial Real Estate Term Loans”, originally published here at the NAR Blog The Source. Assuming a landlord and tenant can come to terms on a reasonable budget for the desired space improvements, typically called a tenant improvement (TI) allowance, the landlord can structure the lease in a way that ensures he/she recovers his/her investment over the term of the agreement. The landlord can choose to do one or more of the following: raise the base rent, accelerate the growth of the lease rate, or extend the lease term.
2) Accept Seller’s Note – A motivated commercial property owner can sell their place a lot faster if they are willing to help buyers get the financing they need. It is typically a lot easier to secure funding for acquisition and renovation if the total loan requested is 80% or less of the total property value, which is called a loan to value (LTV) threshold. Unfortunately, most buyers do not have the cash to pay more than 20% of the total negotiated sales price of a commercial property at closing. So, the seller can either loan the buyer the remaining amount of money needed or reduce the sales price of the property. Given that owners should always aim to get top value for their assets, the seller note option is a better solution. In this case, a seller’s note could effectively be put in place to ensure the buyer qualifies for the loan. A seller’s note is an agreement that requires the seller to accept payment from the buyer on the balance of the sales value of the property at some later date(s). The seller may also require the buyer to pay interest on the monies owed until the balance is fully repaid. The one key requirement is that the seller’s loan must be subordinated to that of an institutional lender. For example, a buyer looking to acquire a 5,000 square foot retail bakery shop in a downtown commercial location for $95 per square foot with a planned renovation budget of $17 per square foot would need to come up with a grand total of $180,000. In this case, the buyer puts $95,000 down (17%) and the seller’s note covers the remaining $85,000 (15%). This combination ensures the buyer will not exceed a lender’s 80% loan to value maximum. By offering a seller’s note, an owner can get a deal done faster without reducing the sales price of the property. In addition, the seller protects him/herself by filing a lien and securing the property as collateral until his/her loan has been repaid. Lastly, the seller receives a fee from the buyer in the form of interest payments (typically 5% to 15%, depending on the risk profile of the deal).
There is no wall that cannot be scaled and no bridge that cannot be crossed when it comes to getting a commercial real estate deal done. The real opportunity is to complete a fair transaction for buyer-seller or landlord-tenant. Tenant improvement negotiations are one area that leaves both parties typically feeling unsatisfied. It’s important to know that there are win-win options to get commercial space modifications done. All you need is the willingness to be creative and flexible on both sides.
ABOUT THE AUTHOR
Chinwe is the CEO & Co-Founder of FundWell. Chinwe has a strong personal interest and a professional track record devoted to helping organizations raise capital. She co-founded, capitalized, and operated a boutique consulting firm that over the last seven years has successfully raised a total of $120 million in grants, competitive loans, tax incentives, government subsidies, and owner equity financing on behalf of clients across the country. Chinwe’s consulting experience includes McKinsey & Company, where she provided financial and strategic business advisory services to Fortune 1000 company executives, and while at Monitor Company (now owned by Deloitte) she provided strategy and financial analysis for public and private sector clients, and managed a $3 billion dollar real estate account. Chinwe has a B.A. in Economics from Harvard College and is a Henry Crown Fellow of the Aspen Institute.
FundWell (www.fundwellre.com) is an online resource that prequalifies and connects commercial real estate investors and small businesses seeking funding with a growing number of bank loans, non-bank debt funding, and other credit related financing options.
FundWell delivers a 75% loan approval rate in a marketplace where they typically face a 30% approval rate. FundWell helps commercial real estate brokers increase deal flow and speeds up closings by referring their clients to prequalified lenders that will fund their real estate needs and business expansion plans. FundWell also helps real estate brokers access financing to grow their businesses.
Since 2012, FundWell’s online financing marketplace and financial health information has reached over 24,000 small businesses, working in partnership with over 300 lending partners across the country that span 13 different types of loan products from conventional bank loans and SBA loans to factoring, equipment loans and commercial real estate loans.