A guide to commercial lease incentives, for tenants

January 6, 2019 | Commercial Real Estate

Commercial lease incentives are payments or concessions offered by a landlord to:

  • encourage a new tenant to sign a lease, or
  • to entice an existing tenant to renew.

In Australia, incentives have become a permanent part of the commercial leasing landscape, which makes them an essential component of the negotiation journey.

Incentives and rental rates

Incentives allow landlords to adjust their rental rates to reflect changing market conditions and tenant demand. ‘Effective rent’ is the term used to describe commercial property rent after incentives have been factored in. This figure is lower than the ‘face rent’ amount (which doesn’t discount the value of the incentives that a tenant has negotiated with a landlord as part of their lease agreement).

(You can read more about the differences between face and effective rents here.)

Incentives and the market

When tenant vacancy rates in a market are low, incentive levels also tend to be lower. Alternatively, higher incentive levels tend to be offered in markets where there are higher tenant vacancy rates. That’s because tenants have more choice of premises in these markets. Landlords will often compete hard to secure tenants, rather than having empty premises that are generating no rental income for extended periods of time.

The problem?

Most tenants are not aware of the latest incentive levels or the different types of incentives. Incentive levels may also vary per landlord or per building. For example, a 15% incentive may seem like a good deal after two rounds of negotiations and the agent tells you that is the best offer. But is it really?

Types of incentives

Commercial lease incentives can come in many forms and they can vary across Australia depending on market conditions. The most common types of incentives are rent-free periods, rent abatements and fit-out contributions.

Rent-free period

A rent-free period is a time during your lease where you don’t have to pay any rent at all. It usually takes effect at the beginning of a lease (though occasionally it can kick in further down the track) and is indicated as ‘’X months rent-free’’.

For example, imagine that a tenant negotiates a six-month rent-free period on a five-year lease of office premises and that the monthly face rent is $75,000. This rent-free period would save the tenant $450,000 (i.e. 6 x $75,000). This would represent a saving of 10% on their total face rent over the full five-year lease term (i.e. they would pay $4,050,000 in effective rent instead of $4,500,000, which is a discount of $450,000).

A rent-free period may be appropriate for tenants who will take time to generate cash flow.

Rent abatement (reduction)

A rent abatement is essentially a reduction in rent spread over the commercial lease term of a commercial property. It is usually represented as a dollar or percentage discount.

For example, imagine that a tenant negotiates a 10% abatement (reduction) on their face rent of $75,000, instead of the six-month rent-free period outlined above. This would mean they would pay 90% of their face rent as their effective rent each month (i.e. $67,500 instead of $75,000). This is a saving of  $7,500 per month, which equates to $450,000 over the five-year life of the lease.

Fit-out contribution

fit-out contribution is a lease incentive that applies to a tenant’s fit-out – the process of installing fittings and fixtures, appliances and decorative touches to an interior office space.

For example, a tenant may negotiate to be reimbursed for $450,000 of their office fit-out costs instead of opting for a rent-free or a rent-abatement period.

If you negotiate payment for fit-out works, ask your landlord if there are any preconditions that you’ll need to meet before you qualify for the incentive payment.

  • Will they take whole or partial ownership of the fit out once completed?
  • Will they ask for a so called ‘incentive guarantee’ to cover the incentive?
  • Will the payment be made on a reimbursement basis or will you be required to submit all your invoices to your landlord as they come through?

Most  landlords will choose to pay fit-out contributions on a ‘reimbursement’ basis, provided that their tenant has (you have):

  • signed the lease
  • supplied a bank guarantee or security deposit
  • taken out insurance
  • provided quotes and plans for the works for the landlord’s prior approval, and
  • submitted receipts.

Nonetheless, it’s worth discussing the conditions of a fit-out incentive before signing your lease.

How to negotiate tenant incentives

Landlords are always eager to attract high-quality tenants on long-term leases, especially in rental markets with high vacancy rates. Offering a commercial lease incentive package is one way to do it.

As a commercial tenant, it is vital that you learn about the types of lease incentives that you are able to negotiate. Use the following steps as a guide to secure the best possible commercial lease incentive:

  • Work out the kind of incentives that will best suit your business – Rent-free periods and rent abatements can help with cash flow, whereas landlord fit-out contributions can assist with initial set-up costs. Decide what will work best for you.
  • Thoroughly research current market conditions. The ‘generosity’ of the lessor will be largely dictated by their property portfolio, comparable properties and market conditions, so do your research. Even better, enlist the help of an tenant representation specialist. They will give independent insight of what local market conditions are and are able to fasttrack the proces.
  • Understand the tax implications – each incentive type will come with tax implications for your business. So, be sure to consult an accountant or tax professional before making decisions.
  • Hire professionals negotiate on your behalf – A good commercial tenant advisor, knows the market and will bring many years of negotiating experience to secure you the maximum incentive possible and secure tenant friendly lease terms.

Negotiate the best deal

Our team at Tenant CS are tenant representation specialists. We offer a tenant advisory service and a wealth of experience across different markets. So, next time you’re faced with negotiating a new lease or renewal, get us on your side. We’ll bring the full value of our expertise and market knowledge to secure you the best deal possible. 

Get in touch with a member of our team today!

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The Author

Maxwell brings over ten years of commercial real estate experience and currently works as a tenant representation specialist in the tenant representation Sydney team. He says some of his more memorable projects over the years include an 11,000sqm lease renewal in Islamabad, Pakistan, and the sale of a 200sqm commercial unit on the Canals of Amsterdam.

In his spare time, Maxwell is a loving father, backcountry skiing fanatic, boat lover and food enthusiast.

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