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Moving into a new commercial space and renovating it to suit your business is a significant investment. From HVAC systems and electrical upgrades, to full office fitouts, these ‘tenant’s improvements’ are often costly assets to be added to your business expenses. 

Protecting these assets is a crucial step that is often overlooked – there is a common misconception that the landlord’s insurance on properties covers all additions or variations to the buildings. However, this usually isn’t the case.

In this article, we will explain Tenant’s Improvements, how to navigate complex rental obligations, the vital importance of correct demarcation, and how to accurately calculate reinstatement costs to ensure you’re not missing out in the case of a total loss on your rented property. 

What are Tenant’s Improvements (TIs)?

When signing a commercial lease, tenants may assume that the building and all associated fixtures and fittings are entirely covered by the landlord. However, typically, landlords will only insure the bare shell of the building or the building in its physical state at the exact moment it is handed over to a tenant. This includes any external works, hardstandings and outdoor areas up to the site boundary. 

Any modifications that a tenant makes during the lease period is usually their responsibility to insure – these changes in the nature of fixtures and fittings to the building are called Tenant’s Improvements (TI). This includes structural alterations or fitouts that are designed to make the space operational for a business. 

Here are some Tenant’s Improvements examples:

  • Mezzanine floors 
  • HVAC systems (heating, ventilation and air conditioning) 
  • Electrical and infrastructure upgrades 
  • Internal partitioning and office fitouts, including suspended ceilings and purpose-built meeting areas 
  • Specialised operational installations, such as walk-in refrigerator or commercial kitchen setups

Tenants often mistakenly believe that their landlord’s insurance covers changes to the building. However, in the case of a total loss in an insured event, such as a fire or flood, the landlord’s policy may not pay for the tenant’s losses. Without their own insurance for these improvements, tenants may end up out of pocket for anything they have lost.

Navigating lease obligations 

Understanding which party is obligated to insure specific elements of a commercial rented building is rarely straightforward. 

While a lease contract may specify that that landlord is responsible for insuring the building, the legal definition within that agreement may exclude any tenant-installed modifications. However, when it comes time for tenants to renew their leases, the insurance obligations can change in accordance with new lease terms, meaning the responsibility of insuring these changes may revert to the landlord. 

For example, if the landlord insures the building it is a landlord’s discretion to either absorb a tenant-installed fitout into their insurance cover, or push more liability onto the tenant to insure it themselves. This should be made clear to both parties to ensure that every asset is adequately covered. For full insuring and repairing leases, there is less likelihood of a gap in insurance.

For organisations managing multi-site properties, a one-size-fits-all approach to their insurance introduces severe risk. Leases negotiated at different times, with different landlords, or under varying circumstances and market conditions will inevitably create discrepancies and contrasting clauses. An asset that is classed as the landlord’s obligation to insure at Site A may be deemed the tenant’s insurance liability at Site B. 

Relying on broad assumptions often leads to inadequate cover, which opens further cases for the issues that arise with underinsurance, overinsurance, and even double insurance cover. 

For businesses to best protect their finances, insurance obligations must be reviewed and audited on a building-by-building or site-by-site basis. 

Demarcation of assets

There is often a difficulty in drawing a line between what constitutes a Tenant’s Improvement (TI), and what is simply contents. One of the most common causes of friction in insurance claims is what constitutes the building, and what counts as contents. Getting this distinction correct to ensure all of your assets are properly insured is crucial. As a reminder: 

  • Buildings: typically includes fixed items permanently attached to the structure of the property, such as mezzanine floors, ceilings, air conditioning units, and purpose-built meeting rooms 
  • Contents: loose items such as demountable internal partitions, desks, and office furniture

This demarcation of assets is crucial as insurers may apply different premium rates to TIs compared to contents. For example, if a tenant spent a substantial amount on specialised TIs, such as integrated LED lighting and suspended acoustic ceilings, these assets will be permanently fixed to the structure and are less likely to face minor accidental damage. Therefore, insurers will often apply a lower premium rate to them. 

Loose office furniture and computer equipment may face a higher premium rate due to the perception by insurers that they carry a much higher risk of theft and damage. 

If the tenant were to categorise their LED lighting and acoustic ceilings under general contents, they could face an inflated premium rate for those elements every year. 

Failing to properly assess and declare the appropriate demarcation leaves businesses exposed to premium overpayment, or claims disputes and the application of ‘average’ clauses. Getting an accurate insurance valuation is crucial to not only prevent any financial losses, but can also protect from reputational damage or legal costs. 

Historic costs vs reinstatement costs 

When determining declared values, many businesses will turn to their fixed asset register for a starting figure. While referring to the original historic cost of a particular asset is a useful beginning point, simply relying only on this and declaring what a fitout or asset originally cost as the basis for current insured values can be a huge mistake. 

In the case of reinstating assets, their value will be impacted by the rising costs of labour, professional fees, permit costs, building materials, and plant and machinery from inflation. As these expenses continue to rise, the original cost of the fitout becomes irrelevant, especially if the application of depreciation is adopted.

Determining the correct declared value requires a thorough item-by-item analysis. Relying on historic costs is often where insurance gaps occur. In the event of total loss or a need to repair, this would typically cost much more in today’s economic climate. 

However, the converse can be true. The tenant may have spent a considerable amount of costs in bringing a building up to an acceptable standard for occupation including redecoration, changing lights, moving internal walls, resurfacing flooring or external areas, and bringing the space up to current building code standards. In the event of reinstatement of the building, these costs would likely be incorporated into the new rebuild cost, so the tenant does not need to separately reflect this.

An accurate, up-to-date Reinstatement Cost Assessment (RCA) ensures that these modern costs are reflected in their insurance policy, so that the assets can be adequately covered.

Best practices for tenants 

Accurately identifying and valuing Tenant’s Improvements is essential to ensuring adequate insurance cover in the face of a total loss of an asset. Here is a handy checklist of best practices for tenants to consider:

 1. Review leases on a site-by-site and building-by-building basis 

For businesses with multiple sites and buildings in their portfolio, it is crucial to review insurance policies and reinstatement costs individually, particularly following lease renewals or the signing of new contracts. 

2. Establish clear asset demarcation 

Understanding and separating fixed building alterations from moveable equipment and general contents will help businesses to prevent any assets being underinsured or missed entirely. This will also ensure an appropriate premium rating. 

3. Account for modern reinstatement costs

Ensure that valuations do not use depreciated costs, and instead account for inflation and current reinstatement costs for crucial aspects such as labour, building materials, and professional fees.

4. Arrange an up-to-date Reinstatement Cost Assessment 

Regular professional valuations from RICS-approved valuation specialists helps businesses to eliminate coverage gaps, protect against underinsurance, and ensure that they are paying accurate premiums. 

Time to assess your declared values and stay protected

By taking a careful site-by-site approach to assessing and declaring reinstatement values, business tenants can ensure that their operational assets remain fully protected when a loss occurs. But don’t wait for disaster to strike – reviewing your property’s insurance on a regular basis is a sure way to ensure that you are fully protected in line with changing values. 

At Charterfields, we specialise in reinstatement cost assessments, with particular expertise in the assessment of Tenant’s Improvements and navigating complex lease arrangements. Feel free to get in touch with us if you’d like a no obligation proposal to assess your assets and ensure you’re adequately covered.