When you lease a property, do you move into the space as it exists?
It's understandable that a new tenant would want to make a few changes to the property here and there before finally moving in. There could be changes to the included furniture, fixtures, flooring, facilities, etc., depending on the needs of the tenant who is moving in.
Property leases are created upon mutual agreement between the lessor and the tenant – any improvement required to be made to the property before the move needs to be included in the lease. This is where leasehold improvements come in.
Let’s understand in detail what leasehold improvements are, how they work, and how to account for them in your books.
Leasehold improvements can be defined as the changes or modifications done to a property to suit the tenant's requirements before signing the lease.
In simpler terms, leasehold improvements are modifications that the tenant wishes the lessor to make to the property before finalizing the move.
This could include all manner of modifications like constructing partitions, changing tiles or flooring, fixture repair, adding appliances, etc.
The lessor may provide incentives to the tenant by incentivizing the payment of leasehold improvements from their side. However, in certain cases, the leasehold improvements are required to be covered by the tenants themselves.
Everything depends on the mutually agreed terms and conditions of the lease agreement between the parties involved.
There isn’t a specific mechanism for the working of leasehold improvements. When a landlord entertains potential tenants, it is the tenant’s job to clearly communicate to the landlord about the changes they need to make to the property.
Before any lease is created or signed, both the landlord and the tenant must come to an agreement regarding the following:
It is necessary to discuss all these conditions before leasehold improvements are finalized and put into the lease agreement.
Typically, any leasehold improvements done to the property belong to the landlord unless the lease mentions otherwise. If the tenant is allowed to take these improvements with them when they move, they must be removed without damage to the property.
Quick tip: Leasehold improvements may happen in the middle of the lease term as well. It can become challenging to keep track of the changes and keep the leases updated. In such scenarios, it makes sense to design your own lease management software using no-code platforms like LeasO.
Leasehold improvements are typically paid for by the landlord; however, sometimes, the tenant may be required to cover certain specific expenses depending on the type of improvement requested. It changes with every landlord.
There are four distinct types of leasehold improvements that are practiced today:
Let’s understand each of these in more detail.
Tenant improvement allowance is a mechanism where the landlord sets a leasehold improvements allowance in the contract on a per-square-foot basis.
This allowance is enough to cover the budget for the improvements that the lessee makes to the property.
This mechanism is popular because it allows the tenant to oversee the improvement process and frees the landlord from responsibility.
A building standard allowance works on the principle of offering modification packages to the tenant.
The landlord usually puts these packages together – a fixed-cost bundle of listed improvements that the tenant can choose from.
This mechanism is good for tenants who can’t oversee the leasehold improvements being made. The responsibility rests on the landlord.
Much like the word “turnkey,” these leasehold improvements are entirely the landlord’s responsibility.
The only involvement required from the tenant is to submit a list of requirements, cost estimates, and plans to the landlord to execute on the property at the beginning of the undertaking of the lease or the lease commencement date.
All the costs are borne by the landlord.
This mechanism of leasehold improvements works similarly to tenant improvement allowance, with the tenant overseeing the modifications.
One additional incentive is that the landlord offers discounted rent for a month (or a few months) or reduced rent for a certain period of the year, allowing the tenant to save on the costs of leasehold improvements in some way.
Leasehold improvements are, ultimately, treated as depreciable assets of a property since they are a part of the building.
As such, they do not attract any tax deductions. There may be conditions on allowing for deductions in tax because of leasehold improvements that differ from region to region.
According to accounting experts, it is prudent to count as an expense any leasehold improvements made that do not exceed the company’s capitalization limits.
If they do exceed the limit, you can consider capitalization and amortization of the total over the life of the leasehold improvements made.
Leasehold improvements have become a necessary part of renting out a property. It has to be suitable for a tenant to move into - and it falls on the landlord's shoulders to ensure that the lease agreement reflects everything with transparency.
Using custom-designed software for lease management can help landlords reduce the amount of work required for modifying leases with leasehold improvements.
LeasO, a no-code platform, provides your business with the right tools to design such software that fits your requirements to the T. To know more about how no-code platforms can help with leasehold improvements, get in touch with us.