Tenants Improvements: Who’s Responsible?
In an effort to attract a growing customer base, business owners who lease property will often improve their space. From simple changes in wall covering to extravagant custom designed upgrades, business owners and lessors alike can reap the benefits of upgrading interior spaces.
Yet, without paying special attention paid to lease agreements and insurance provisions, even a minor damaging event such as a fire can leave both parties empty-handed. The relationship between lessor and tenants can be complex. Understanding how property improvements are owned, used, and insured can mean the difference in quickly reopening or closing your doors forever.
Defining Tenants Improvements
Improvements, also synonymous with “betterments,” include most beneficial changes made to real property. Further defined, improvements increase the value of real property and are upgrades made by or for the benefit of the tenant which are permanent. Improvements may include a wide variety of changes, including the adding or upgrading of:
- Wall coverings
- HVAC systems
- Lighting fixtures
- Ceiling upgrades
- Electrical systems
- Plumbing systems
- Permanent flooring
From an insurance perspective, improvements are referred to as “permanent additions or changes made to a building by a lessee at his or her own expense that may not be legally removed.” The contract between the tenant and lessor determines whether additions or changes may be legally removed. Typically, those items which may be removed would be considered “business personal property” or contents, which can be insured on their own tenant policy.
Interest and Ownership of Improvements
Tenants improvements and betterments are purchased, installed, and paid for by the tenant. Under most contracts, the landlord usually retains ownership of the upgrades after they have been installed.
However, the tenant does retain an insurable interest. The interest exists in the use of the installed improvements. This interest ceased at the same time the lease agreement terminates. To illustrate the relationship between the tenant, landlord, and the improvements, let’s use the following example:
John owns a clothing store located in a retail plaza. He leases spaces from the plaza owner, ABC Shops, LLC and makes a number of improvements since moving into the space including adding the following:
- Wall paneling
- Updated flooring
- Recessed lighting
- Separate office space
The lease John signed with ABC Shops states any improvements John makes to his unit becomes the landlord’s property at the time they are installed. But, John will have the ability to use the improvements for the length of the lease. This means if the improvements were damaged or destroyed, John would lose his use interest and the landlord would lose the asset value of the improvements.
Lease agreements need to clearly answer four essential questions:
- Who owns improvements and betterments during and after the lease term?
- Who is responsible for repairing or replacing improvements and betterments?
- Who is responsible for insuring improvements and betterments?
- How must improvements and betterments be insured?
Knowing the distinctions between each responsibility and responding accordingly will alleviate most disputes if a claim were to occur. Be sure to review lease agreements with a business attorney and your insurance coverage with a licensed insurance agent.
Insuring Tenants Improvements
Improvements and betterments may be insured by either the tenant or the landlord. The property lease must clearly state which party is responsible for the insurance. In addition, it is advisable the lease also specify the terms and limits of insurance required. Who is responsible for the insurance usually is also responsible for repairing or replacing damaged property.
When insuring improvements and betterments, you have a choice between insuring at the replacement cost value or actual cash value. Which value determination is to be used should also be defined in the lease agreement. If an actual cash value policy is all that is required, who is responsible for the additional cost of replacement will also need to be identified in the lease.
Other terms of insurance also should be carefully considered. Depending on the age of your property, think about adding ordinance or law coverage to pay for the increased cost of rebuilding to newer codes. Also, review coinsurance clauses can dramatically impact the amount of out-of-pocket expense required to repair or replace improvements.
When entering into or renewing a commercial lease agreement, it is vital for both tenants and landlords to carefully examine the terms of the agreement. Overlooking any one of the four essential questions could lead to a dispute or even worse, a financial disaster.
To learn more about insuring improvements and betterments, contact the experts at demontagency.com at (800) 522-1997. Our licensed insurance experts will be happy to answer any questions you have.