Last modified on January 6th, 2016
By Bryan Ives
There are pros and cons associated with allowing residential tenants to invest in leasehold improvements during their tenancy. Deciding if encouraging tenant improvements is right for your property depends on your short-term and long-term financial goals.
Temporary vs Traditional Leasehold Improvements
Before you decide if incorporating a residential leasehold improvement strategy for your multifamily property is wise, you must have a clear picture of the benefits and pitfalls involved and understand how temporary improvements differ from permanent upgrades.
Temporary leasehold improvements typically involve minimal structural changes. Residents may want to undertake modifications that make the space more livable and aesthetically appealing. Temporary improvements are reversible – they can be “undone” at the end of the lease without causing extensive damage that requires remediation to return the home to its original condition.
Traditional leasehold improvements involve more extensive structural changes and include structural build-outs like adding or moving walls, replacing windows and upgrading appliances. Ownership of improvements reverts to the property owner/landlord when the lease expires.
Added Value and Future Benefits
One of the major benefits of allowing tenant leasehold improvements is the boost in customer satisfaction that comes from designing a space is customized to one’s lifestyle. This enhanced satisfaction often translates into renewals.
Two other potential windfalls for property managers are improved marketability and tax advantages in the form of depreciation. Some states and municipalities have a complex tax code for commercial and residential leasehold improvements; please check with all tax authorities before making a final decision.
Under GAAP (generally accepted accounting principles), improvements have a useful life of approximately 15 years. However, experts caution that IRS rules are fluid; changing frequently with extensions and renewals at the whim of Congress. Before initiating a new policy, contact your financial advisor or an IRS accountant to confirm allowable property modifications and amortization time tables.
Potential Pitfalls for Property Managers
One of the most obvious potential pitfalls for managers who choose to allow full-scale leasehold improvements for residents is dealing with floor plan changes. Apartment home communities typically offer two or three floor plans consistently throughout the property. Some landlords may hesitate to relinquish control over the interior layout.
Marketing materials may need to be changed as each lease expires, if the scope of change significantly alters traffic patterns or room sizes.
To overcome added expense associated with updating marketing material, property managers could replace print brochures and marketing materials with digital brochures on virtual tours. Although there would still be some costs associated with updating online tools, printing costs would be eliminated.
Another way to control added expenses would be to limit the number of homes available for leasehold improvements.
Costs vs Return on Investment
Adventurous property managers may embrace leasehold improvement arrangements with residents to create a unique apartment community with diverse floor plans and interior design features. If monitored properly, the property owner enjoys increased property value and the residents can design home office space, open floor plans and sleeping quarters that truly fit their lifestyle and decorating preferences.
What do you think? Is your property ready for more flexibility?