Tenants Improvements and Betterments

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Many business owners make upgrades to buildings they rent from a landlord. In commercial property insurance, these upgrades are called tenants improvements and betterments or TIBs. The following example demonstrates the types of improvements a tenant might make.

Example

Larry owns Luxury Leathers, a leather goods shop located in a strip mall. Larry operates his business out of retail space he rents from the mall owner, Shopping Centers Inc.

Larry has made a number of improvements to his space since Luxury Leathers moved into it two years ago. These include new recessed lighting, new carpeting and a small office he has built behind the retail area.

The lease between Larry and his landlord states that any improvements Larry makes to the building during the term of the lease become the property of the landlord at the time they are installed. The landlord is then responsible for insuring the property. Shopping Centers Inc. has purchased a commercial property policy to cover the building and any improvements to it.

The improvements Larry has made to his store are ultimately owned by the landlord. Yet, Larry will have the use of this property for the remainder of his lease. Thus, Larry has a "use interest" in them, meaning an insurable interest in their use. If the improvements are damaged or destroyed by a fire or other peril, Larry could lose the use of them.

Fortunately, his use interest can be insured under a commercial property policy.

Definition of TIBs

Many commercial property policies define tenants improvements and betterments as fixtures, alterations, installations or additions to a building you occupy but don't own. That is, TIBs are items you have purchased or installed at your expense but cannot legally remove.

 

Examples of TIBs are the lights, carpeting and office Larry has installed in his store. This property became part of the building once it was installed. If Larry moves to another location after his lease expires, he cannot take the improvements with him. Larry doesn't own them, and he will damage the building if he attempts to remove the property.

Who Insures TIBs?

TIBs may be insured by either the tenant or the landlord. Which party is responsible for insuring such items should be clearly stated in the lease. Otherwise, disputes can arise over which insurer, the landlord's or the tenant's, is liable for a loss involving damaged TIBs.

The lease should also specify when ownership of TIBs passes from the tenant to the landlord. This often (but not always) occurs when the improvements are installed in the building.

Insurance Coverage for Landlord

Suppose that the lease between Luxury Leathers and Shopping Centers Inc. requires the landlord to insure TIBs. Such property is automatically covered under a typical commercial property policy. Most policies cover the building scheduled in the policy as well as completed additions and fixtures (meaning property permanently attached to the building).

Thus, the carpeting, recessed lights and office Larry has installed will likely qualify as covered property under Shopping Centers Inc.'s property policy.

The value of the building increases by the value of the TIBs. For instance, if Larry spent $15,000 on his building improvements, the value of the building increased by $15,000 when those improvements were completed. Shopping Centers Inc. must ensure that the building limit on the policy is increased by the value of the TIBs. Otherwise, the building may be underinsured. If a loss occurs and the landlord has failed to purchase adequate limits, the landlord may incur a coinsurance penalty.

Insurance Coverage for Tenant

If the lease requires the landlord to repair or replace damaged TIBs, then the tenant need not insure these items. Otherwise, the tenant should make sure they are covered under the tenant's property policy.

Most commercial property policies automatically cover, as business personal property, a tenant's use interest in TIBs.

Depending on your policy, TIBs may be covered on a replacement cost or actual cash value basis. Losses are typically covered in full only if you make repairs "promptly" (this word isn't defined). If you do not repair TIBs promptly, your insurer may pay only a portion of their original cost based on the following formula:

Original cost X number of days from date of loss to the expiration of your lease / number of days from installation of improvements to the expiration of the lease

For example, suppose that Luxury Leathers signed a five-year lease on January 1, 2014. Larry completed the improvements on January 1, 2015. All of the improvements were destroyed by a fire on January 1, 2016. Larry's insurer will not pay more than the following:

$15,000 X 1095 (three times 365) divided by 1460 (four times 365) = $11,250

Your insurer will not pay anything if your landlord repairs or replaces the damaged improvements.

Trade Fixtures

While Larry cannot tear out the TIBs he installed, he can remove a category of property called trade fixtures. Trade fixtures are items installed by the tenant that the tenant expects to remove when he or she vacates the building. These items remain the property of the tenant.

For example, suppose that Larry installs new cabinets in his store for displaying his leather goods. Larry intends to take the cases with him after his lease expires and he moves to another location. Even though the cases may be attached to the building, they are considered trade fixtures rather than TIBs. Other examples of trade fixtures are computers, vending machines and machine shop equipment.

To avoid disputes between the landlord and tenant, the lease should specify the types of property that are considered trade fixtures. Because trade fixtures remain the property of the tenant, the tenant is responsible for insuring them.