TI/LC Reserves

How a TI/LC reserve works

When a commercial lease ends, the landlord does not simply hand over the keys to the next tenant. A new office tenant wants walls moved, ceilings and flooring changed and wiring run. A retail tenant wants a storefront and a fitted kitchen or sales floor. The landlord usually pays part or all of that work, either by doing it directly or by giving the tenant a per-square-foot tenant improvement allowance. A broker then collects a leasing commission, typically a percentage of the rent over the lease term, and landlords often pay for the tenant's broker as well.

None of that cost appears in a normal month. It arrives in clusters, whenever several leases expire close together, and it can be larger than a year of the building's net income. A lender knows that if the borrower runs short of cash when a big tenant leaves, the space sits empty, the income falls, and the loan is at risk. The TI/LC reserve is the lender's way of making sure the money exists when the leases roll.

Expected re-leasing cost = Rolling square feet × [ (renewal share × renewal TI+LC per sq ft) + (new-tenant share × new-lease TI+LC per sq ft) ]

Divide the result by the number of years in the loan term and you have the annual reserve; divide that by twelve and you have the monthly deposit, if the lender collects one.

Underwritten reserve vs. funded reserve

As with replacement reserves, the same words describe two different things, and borrowers are often caught by the difference.

• Underwritten (a deduction). The lender subtracts an annual TI/LC allowance from income when it calculates net operating income. No cash moves, but the lower NOI means a lower loan amount, lower coverage and a lower debt yield.
• Funded (an escrow). Cash goes into an account the lender controls. It is funded at closing, through monthly deposits, or when a trigger occurs, and it is released when you document the work.

A loan can have one or both. A bank lending on a small retail center might underwrite a deduction and never collect a deposit. A conduit loan on an office building often does both. Ask which one applies before you rely on a quoted loan amount.

Worked example: a 60,000-square-foot office building

The figures below are assumptions for illustration, not quoted requirements. Suppose a lender is reviewing a 60,000-square-foot office building with a 10-year loan term. Its rent roll shows leases covering 45,000 square feet expiring during the term (20,000 in year 3, 15,000 in year 6 and 10,000 in year 9). The lender assumes 70% of tenants renew and 30% are replaced by new tenants, and uses these re-leasing costs:

Lease type	Tenant improvements	Leasing commissions	Total per sq ft
Renewal (70%)	$15.00	$4.00	$19.00
New tenant (30%)	$40.00	$10.00	$50.00

Step	Result
Blended cost per rolling sq ft: (0.70 × $19) + (0.30 × $50)	$28.30
Total re-leasing cost: 45,000 sq ft × $28.30	$1,273,500
Annual reserve over 10 years	$127,350 (about $2.12 per sq ft of the building)
Monthly deposit if escrowed	$10,612.50

Now see what that does to the loan. Assume the building produces $720,000 of NOI before any TI/LC deduction and the lender requires a 10% minimum debt yield:

Item	Before TI/LC	After TI/LC
Net operating income	$720,000	$592,650
Maximum loan at a 10% debt yield (NOI ÷ 0.10)	$7,200,000	$5,926,500

The deduction cuts proceeds by $1,273,500, exactly the total re-leasing cost, because a 10% debt yield multiplies each dollar of annual NOI by ten and the reserve spreads the cost over ten years. You can test this reasoning with the debt yield calculator and the NOI calculator.

For a single suite, the TI allowance calculator shows the landlord's side. Take 10,000 square feet of office space where the tenant gets a $40-per-square-foot allowance and the build-out actually costs $55 per square foot. The allowance totals $400,000 against a $550,000 build-out, so the allowance covers 73% of the cost and the tenant pays the other $150,000 itself. If the landlord spreads the $400,000 over a five-year lease, that is about $6,667 a month. A lender sizing a TI/LC reserve is adding up numbers like these for every lease that will expire during the loan.

How lenders decide the number

Several inputs drive the figure, and each is a place you can push back with documentation.

• The rent roll. The lender reads the rent roll and builds a rollover schedule showing how many square feet expire each year. A building with a few long leases carries a small reserve. One with half its space expiring in years two to four carries a large one.
• Renewal probability. Lenders weight renewals and new leases differently because renewals generally cost less: the space is already built out and no new broker may be involved.
• Market costs. Allowances and commissions vary by property type, market and building class. Office improvements cost far more per square foot than industrial space, and retail falls in between, so reserve rates differ widely by property type.
• Tenant credit and concentration. A single tenant that occupies most of a building, or that is likely to leave, may lead the lender to require a dedicated reserve or a cash sweep that starts when that tenant gives notice or goes dark.
• Existing in-place obligations. Unfunded allowances the landlord already owes under signed leases are usually treated separately. Lenders typically require them to be paid before closing or reserved in full.

Types of TI/LC reserves

Loan documents use several structures. These structures appear in public securitization filings; the terms vary deal by deal and are not market standards.

• Upfront deposit. A lump sum at closing, often paired with monthly deposits afterward.
• Ongoing monthly deposit. A level monthly amount, sometimes stated per square foot per year, often until the balance reaches a stated cap.
• Balance cap. Deposits stop at a stated balance and restart if it falls below, so cash is not locked up indefinitely.
• Springing or sweep reserve. Nothing is collected until a trigger such as a major tenant giving notice, going dark or filing for bankruptcy. Then all excess cash flow is swept into the reserve; one early-2000s conduit loan swept until the balance reached $750,000.
• Letter of credit or guarantee. Some sponsors post a letter of credit instead of cash, which keeps their money working while still giving the lender the protection.

TI/LC reserve vs. similar terms

Term	What it covers	How it differs
TI/LC reserve	Re-leasing costs: tenant build-outs and broker commissions	Driven by the lease expiration schedule
Replacement reserve	Roofs, HVAC, paving and other building components	Driven by building age and condition, not tenancy
Tax and insurance escrow	Property taxes and insurance premiums	Known bills due on a calendar
Renovation holdback	Planned construction or repositioning work	A one-time draw tied to a business plan, common on bridge loans
Free rent	Rent abatement a landlord gives a new tenant	Lost income, not cash outlay; lenders may reserve it separately

Free rent deserves a note: it is a concession like TI, but a lender usually handles it as an income adjustment or a separate reserve rather than inside the TI/LC line. Ask whether your lender combines them.

Why lenders care

A commercial property is worth what its leases are worth. When a lease ends, the loan is repaid from the building's income and, if that fails, from selling it. A building with heavy rollover is riskier at exactly the point the lender is most exposed:

• It protects income. If the borrower cannot afford the build-out a new tenant demands, the space stays vacant and NOI falls.
• It protects exit value. A buyer or refinance lender will discount a building with unfunded leasing costs, so the reserve supports the lender's takeout.
• It keeps the sponsor's money in the deal. Cash held in reserve is not distributed, so a borrower cannot take dividends from the building and leave the next tenant unfunded.
• It affects every sizing test. Because the reserve lowers underwritten NOI, it reduces the DSCR, the debt yield and the cap-rate value in a single step.

What to watch for and negotiate

• Ask for the rollover assumptions. Request the lender's renewal probability, TI and commission rates per square foot, and downtime assumptions. If the lender's per-square-foot costs are above what your recent leases actually cost, show the signed leases.
• Get the structure in the term sheet. Is it underwritten, escrowed, or both? Is there an upfront deposit? Is there a cap? Reserves that first appear in the commitment can reprice the deal after you have paid for third-party reports. Compare with the term sheet and the commitment letter.
• Negotiate a balance cap. A cap stops deposits once the account holds enough for the foreseeable rollover, so you do not tie up cash forever.
• Ask for credit when leases are extended. If you renew a big tenant early, push for the reserve and its cap to step down. Some loan documents build in this step-down; ask whether yours does.
• Prefer triggers to blanket deposits. If the main risk is one tenant, offer a springing reserve tied to that tenant rather than a deposit on the whole building.
• Understand the release process. Draws generally need the executed lease, invoices, lien waivers and sometimes an estoppel certificate, and disbursements follow completed work. Ask how long a draw takes and whether there is a minimum amount.
• Watch the covenants. A lender may require the reserve to be topped up or replace deposits if a major tenant leaves, and a breach can be a default under the loan covenants.
• Keep your own leasing budget. The lender's reserve protects the lender. Your own plan should cover vacancy, free rent and market allowances that exceed the lender's assumptions.

TI/LC reserves by property type

Office. The highest per-square-foot costs and the most common reserve. See office building loans.

Retail. Shopping centers and strip malls roll many small tenants; anchor tenants raise concentration risk. See retail property loans.

Industrial and warehouse. Lower build-out costs, so smaller reserves, but long vacancy after a big tenant leaves can still matter. See industrial property loans and the guide to warehouse and industrial loans.

Medical office. Specialized build-outs are costly and tenants are sticky, which cuts both ways. See financing a medical office building.

Multifamily and owner-occupied. Seldom applicable; lenders use replacement reserves for apartments, and an owner-occupied building has no tenant to re-lease to.

Where TI/LC reserves show up by loan type

• CMBS loans (see also CMBS loan financing): reserves are common, with detailed deposit schedules, caps and cash-sweep triggers written into the loan agreement.
• Permanent and bank loans: an underwritten deduction is nearly universal on multi-tenant property; whether an escrow is collected depends on leverage, rollover and the borrower.
• Bridge loans: leasing costs for a lease-up business plan are usually funded as a holdback against the plan rather than as an ongoing reserve.
• Tenant improvement financing: a different question, how to borrow to fund a build-out, covered on its own page.

The bottom line

A TI/LC reserve is a rollover forecast turned into a loan term. It can lower your maximum loan by a seven-figure amount without any cash changing hands, and it can lock up cash in an escrow for years. Before you accept a quote, get the lender's rollover schedule, find out whether the reserve is underwritten, escrowed or both, and test the result against your own leases. For other reserves a lender may collect, see replacement reserves and escrow and impounds.

Sources: GMAC Commercial Mortgage Securities Inc Form 424B5 (SEC EDGAR, 2003), TI sweep event terms; SEC EDGAR commercial mortgage securitization prospectuses generally for deposit, cap and sweep structures. The structures describe how particular deals were documented, not market standards. Worked-example figures are illustrative assumptions; the TI allowance results were computed with the BestLoanUSA TI allowance calculator.