Why are estimated TIs averaged out over the lease term?
I'm also trying to understand what exactly this means. If a new tenant needs $50 psf, lets say its $1M in total, to build out their space, isn't that provided to the tenant in a lump sum? Doesn't amortizing this number mean that the underwritten NCF will be above what it will be when a large lump sum TI package is provided in a given year?
[{"id": "cua4uyf", "text": "simple simple answer:\n\nYes its paid out as a lump sum (or in other ways depending on lease terms, but my company is always lump sum).\n\nTI's are put on the balance sheet because its an investment into the property, no different then you purchasing new equipment. If you look at it the same way as the equipment you amortize the cost over its useful life of the investment (generally the lease term).", "replies": [], "depth": 1}, {"id": "cubcrwj", "text": "Can you clarify if you are talking more from an accounting perspective or negotiable perspective?  \n\nI look at this as a loan to the tenant.  When we evaluate these, we actually put an interest rate in them and evaluate the base rent separate from the TI portion.  The reusable, or needed portion of the TI is also considered.  So for example it be looked at differently from the landlords side if we are talking a built out office space that really is fine for most tenants or only requires minor TI vs a shell space.  The tenants credit comes into play here too.  \n\nI guess I'm not sure exactly what your question is.  Yes NCF with TI will (or should) be higher than an identical deal with no TI.  Ultimately if something needs to be spent to get the deal done, either the landlord or the tenant is paying it.  If they pay it, they are going to be inclined to pay less rent.  If the landlord is paying it, they will want more rent.  Neither situation really alters the value of the property.  One has a up front cost for the tenant with lower future cash flows.  The other has an up front cost for the landlord with higher future cash flows.  Valuation wise, they are identical provided some assumptions (which probably aren't true) such as both parties having the same cost of funds etc.  \n\nIf you are just talking tax and accounting stuff I have no idea and it might depend whos books you are looking at.  I could see that either being looked at as a loan to the tenant who could then depreciate the build out their selves, or as /u/mnrvr said as an asset the landlord would depreciate.  If that is the question and this isn't a homework problem I'd say you should discuss this with your client's or your cpa for clarification.\n\n", "replies": [{"id": "cube6ay", "text": "I'm talking about a cash flow underwriting that a mortgage loan originator would complete.", "replies": [{"id": "cubealp", "text": "They would look at the cash flow including the ti repayment then reset to market rent at the end of the lease.\n\nTi money is spent. All that matters is what is coming in at that point.  ", "replies": [{"id": "cubehdq", "text": "Wha? I'm saying - in an originator's underwriting, they will use the base rent, reimbursements, vacancy, estimated operating expenses, and then the final thing they'll look at are Capital Expenditures - these will include replacements, tenant improvements, and leasing commissions. \n\nTenant Improvements are typically estimated based on a renewal ratio and a market TI for new and renewal leases. So, for example, a blended TI rate of $10 psf and 10000 sf of space, gives you $100,000 in TIs. However, this number is divided by the average lease term (e.g. 5 yrs.) which gives you the final number, $20,000. My question was - why are we dividing by the average lease term.", "replies": [{"id": "cubephi", "text": "As opposed to what?  The in place lease term?  ", "replies": [], "depth": 5}, {"id": "cubevvb", "text": "are you talking about a property with multiple tenants and staggered leases where TI is an ongoing concern of something more single tenant?  \n\nSingle tenant yeah they are going to look at the actual lease when figuring this out and term will matter.  If you have 20 tenants then it will be annualized like you are saying, because thats really the best way to do it.  I guess I'm not sure what else you'd use outside of the average lease term there.  If they want to use 5 and all your leases have 10 years on them I could see your argument.  Add that to the list of 100 things mortgage people do that defys logic and kills deals ;) \n\nI guess I'm not sure what alternate way of figuring out what TI expense to the property is that you are proposing or wondering why they don't use.", "replies": [], "depth": 5}, {"id": "cum8mai", "text": "If there are concerns about big cash outlays early in the project, you can require a cash reserve for some or all of the amount. I don't know the textbook answer, but the experience answer is that the average creates a common way to assess properties of a similar type &amp; gives a more apples to apples comparison. You also usually don't know if there are going to be huge TIs down the road until those spaces come up for renewal. It's really only a known figure if there is an immediate (1-2 year) rollover &amp; the LL knows they need to upfit. ", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}]