As a tenant or business owner looking to lease commercial real estate (CRE) property, you hold a position of advantage. CRE property owners or landlords often seek you out, employing strategies to entice you to sign a lease or renew an existing contract. These strategies typically include incentives, which can serve as attractive perks.
In a competitive market, landlords use incentives to present their properties in the best light. However, while these incentives may seem appealing, they require careful consideration to avoid potential drawbacks. It’s wise to hire a real estate broker or lawyer to examine the agreement before you sign.
Types of Rent: Face Rent vs. Effective Rent
Before exploring the various lease incentives available, it’s essential to understand the two types of rent: face rent and effective rent.
Face rent refers to the baseline payable amount, excluding incentives. In contrast, effective rent represents the total rent after accounting for all incentives. Effective rent is the actual amount you’ll spend on the property and is the figure to compare with other properties on your list. These rent types also help calculate the total savings a tenant can generate over the lease period.
Common Lease Incentives
There are numerous incentives in the market, but the three most common ones are the rent-free period, rental rate reduction, and fit-out contribution.
Rent-Free Period
A rent-free period, also known as abated rent, allows tenants to occupy the property without paying rent for a specified time. This incentive is often offered during the first few months of the lease, providing significant cost savings. It’s particularly beneficial for newly established businesses, as it helps generate sustained cash flow during the initial operations.
However, it’s crucial to remain cautious when considering this incentive. Thoroughly review the lease agreement and consult professionals to ensure the arrangement doesn’t result in long-term disadvantages.
Rental Rate Reduction
A rental rate reduction involves negotiating a lower lease rate, either for a specific period or throughout the lease term. Deciding whether to opt for a rent-free period or a rental rate reduction depends on which option offers greater savings. When making this decision, consider factors such as annual rent increases, market stability, and negotiations with the property owner.
Fit-Out Contribution
A fit-out contribution, also known as a tenant improvement allowance, involves the tenant and property owner sharing the costs of space improvements. This incentive may cover maintenance costs, fixture installations, and other enhancements. Typically, it operates on a reimbursement basis, with the property owner covering a percentage of the total costs.
Before proceeding with this incentive, tenants usually need to provide the following:
- A duly signed commercial lease contract or agreement
- Required insurance documentation
- Receipts for all identified expenditures for reimbursement
- A bank guarantee or security deposit
- Detailed plans for the work, subject to landlord approval
When negotiating a fit-out contribution, both parties should clarify terms such as:
- Ownership of the completed fit-out, either fully or partially by the tenant or landlord
- Whether the landlord must provide an ‘incentive guarantee’ to cover the incentive
- The mode of payment, whether on a reimbursement basis or another method
Additional Lease Incentives
Aside from the three common incentives, landlords may offer other perks, including:
- Cash payments
- Cash-convertible benefits like cars or equipment
- Fixed rent rates that don’t increase during the lease period
- Reimbursement of relocation costs, penalties, or legal fees
- Free furnishings and equipment
- Incentives for exceeding lease liabilities or low-value equipment
- Compensation for inconvenience caused by refurbishment
- Interest-free loans
- Holiday packages
- Pay-out of a tenant’s pending lease commitment to another property
Important Considerations for Lease Incentives
Incentive Taxation
Incentives given to tenants, such as cash, are often considered taxable income. However, if provided during the initial stages of a business, the incentive may be classified as capital and thus exempt from tax. Incentives like reduced rent or entertainment packages, such as holidays, are also typically non-taxable.
Repayment Clauses
One of the most critical reasons to thoroughly review a lease agreement before signing is the presence of repayment clauses. Some agreements include sub-clauses requiring tenants to repay a portion of the incentives if the lease is assigned, surrendered, or terminated before expiration.
Fit-Out Ownership
Tenants should clarify the ownership terms regarding fit-out improvements. It’s essential to specify the roles and duties of both parties concerning fit-out taxation and ownership, particularly upon lease expiration.
Incentive Disclosure
Finally, never hesitate to seek professional assistance when reviewing lease agreements and negotiating terms. It’s better to be safe than sorry. Remember, a lease agreement is a legal document, and your signature legally binds you and the landlord. Although lease incentives can be enticing, don’t let excitement lead to hasty decisions that could result in undesirable consequences or financial loss.
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Meet The LeveragedCRE Investment Team
Phill Tomlinson and Eric Butler are seasoned commercial real estate brokers with over 44 years of combined experience. They lead the LeveragedCRE Investment Team at Commercial Properties, Inc. (CPI) in Scottsdale, Arizona, specializing in investment sales and tenant/landlord representation across the Phoenix and Scottsdale submarkets.
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