Tenant Improvement: What Is It and What Impact Does It Have on the Standard of Mexico's Industrial Real Estate Market?

The term "tenant improvement" (TI) refers to modifications made to a real estate space to adapt it to a tenant's specific needs. These above-standard improvements can be structural or semi-permanent and include changes to walls, floors, ceilings, lighting systems, plumbing, electricity, technology, sustainability, and security. In contrast, furniture, decorations, and external improvements are not classified as TIs because they do not add permanent value to the property.

Tenant improvements are negotiated between the property owner and the tenant as part of the lease agreement. These agreements establish responsibilities for the costs of modifications, the management of the works, and the fate of the improvements at the end of the contract, significantly influencing contractual aspects such as rent and lease duration.

A key aspect is the financial allocation for improvements, known as "tenant improvement allowance," which consists of an agreed sum the landlord provides to finance the improvements. This amount is generally amortized through rent payments and covers the direct costs of the modifications but excludes removable items such as furniture or decoration. Effective negotiation of improvements and the allowance is critical, as it defines financial responsibilities and ensures that the leased space optimally adapts to the tenant's current and future needs.

In this context, it is essential to highlight how TIs can influence the development of the industrial real estate market. According to data from SiiLA, in the last year, the number of Class A properties grew at a faster rate (9%) than Class B (3%). Generally, Class A industrial buildings, which often include substantial improvements to adapt to advanced technologies and sustainability standards, tend to have higher prices than Class B. However, in cities like Mexico City, Guadalajara, and Tijuana, the prices of Class B buildings may be higher due to the scarcity of land available for new developments, leading to a price balance between classes. This dynamic underlines the importance of TIs in adapting the leased space and its impact on the property's market value.

An example of tenant improvements can be seen in warehouse WS01 of the Bernardo Quintana Industrial Park in Queretaro, where the allocation of kVAs (kilovolt amperes) is adaptable to the tenants' requirements. Likewise, SiiLA REsource has documented how, in industrial markets like Ciudad Juarez, the incorporation of evaporative air systems and basic features such as office spaces, lighting, hydraulic concrete paving, dock equipment, and security and fire systems are part of both formal and informal negotiations between owners and tenants.

According to Jaen Pena, General Director of Colliers in Ciudad Juarez, flexibility in TI negotiations leads to developers' greater willingness to negotiate leases that include specific improvements or allow tenants to make their own adaptations more freely. This is particularly relevant in markets with an increased demand for spaces adapted to specific needs, as seen in the logistics sector, where space and functionality requirements vary significantly.

In these scenarios, it is clear that flexibility and adaptability in TI negotiations are crucial to meet tenant expectations and needs and to increase the long-term value of properties. The ability of developers to adapt spaces to current operational and technological demands brings concrete benefits, such as optimizing space use and attracting high-profile tenants. Additionally, in a constantly evolving market, improvements made today can provide a competitive advantage in the future.

For more information on trends in Mexico's industrial real estate market, explore SiiLA Resource or contact us at contacto@siila.com.mx.