Knowing Your Commercial Lease Incentives Before Signing
As a tenant or a business owner looking for a commercial real estate (CRE) property to lease, you are often on the advantage of being sought out by CRE property owners or landlords. These property owners typically employ strategies to entice potential tenants, like you, to sign with their property, or in the case of their existing tenants, to renew their contracts. These strategies include incentives that you can enjoy as perks.
In a competitive market, incentives are used by landlords to put their best foot forward. However, as encouraging as these incentives may be, they also require careful studying and examination to ensure that they do not cause major drawbacks. It is still wise to hire a real estate broker or lawyer to have the agreement examined before you ink your signature in.
Now, before you explore the numerous incentives in the market, you need to understand the two types of rent: face rent and effective rent.
Face rent refers to the baseline payable amount of rent, excluding incentives, whereas effective rent is the total amount of rent after all incentives are taken in. Effective rent pretty much sums up the amount of money you will be spending on the property, and is the amount subject to comparison with the properties in your option list. These two are also often used to compute the total savings a tenant can generate over the period of time indicated in the agreement.
There are numerous incentives in the market, but the three (3) most common ones are the rent-free period, rental rate reduction, and fit-out contribution.
LEASE INCENTIVES
Rent-free period
As the name suggests, rent-free periods, also called abated rent, are incentive schemes that allot a specific time period when tenants do not need to pay for rent. Rent-free periods are often employed in the first few months of the lease. This, indeed, is a cost-saving incentive, making it particularly popular in the market and relatively effective in enticing potential clients.
Rent-free periods are not only beneficial to tenants in terms of saving money within a specific time period, but also in allowing tenants, especially newly established businesses, to generate sustained cash flow in their initial operations in the property in a time when they are still establishing their presence at the spot.
Note that tenants must still remain cautious when working on these incentives. Make sure that you study the lease agreement and hire professionals to examine its technical elements to ensure that the scheme bears no unnecessary drawbacks in the long run.
Rental Rate Reduction
Rental Rate Reduction is part of the negotiation to pay a lower lease rate distributed within a period of time or all throughout the lease.
Essentially, deciding whether to opt for a rent-free or rent reduction is a matter of calculating whichever can provide more savings in your end. In calculating these, also make sure to consider some factors that come in play, such as rent increase per annum, market stability, negotiations with the property owner, etc.
Fit-out contribution
A fit-out contribution incentive, also called tenant improvement allowance, allows the tenants and the property owner to share identified charges, which may include maintenance costs, installation of fixtures and other decorative elements to the property, and other space improvement costs.
This incentive may transpire using reimbursement basis on a certain percentage of total costs identified. Before signing up for this, the tenant is typically required by the property owner to secure the following:
Duly signed commercial lease contract or agreement
Required insurance taken out
Submission of all the necessary receipts of identified expenditures for reimbursement
A bank guarantee or security deposit
Detailed plans for the works subject to the landlord’s approval, including quotes/price
In a fit-out contribution, the tenant and the property owner must negotiate clear and specific terms, such as:
Ownership by tenant or landlord of completed fit-out, either full or partial
Whether the landlord is required to provide ‘incentive guarantee’ to cover the incentive
Mode of payment, either reimbursement basis or other mechanisms
Aside from these three, here are other commercial lease incentives that may be offered by a property owner:
Cash payments
Cash-convertible benefits, such as cars, equipment, etc.
Fixed rent rates which do not arise during the lease period
Reimbursement of relocation costs
Reimbursement of a penalty
Reimbursement of legal fees
Free provision of furnishings and equipment
Lease incentives for exceeding lease liabilities
Lease incentive on a low value equipment
Incentive for the inconvenience generated by refurbishment works
Interest-free loans
Holiday packages
Pay-out of tenant’s pending lease commitment to another property
Other important reminders on commercial lease incentives
Incentive taxation
Case laws often consider cash incentives given to tenants as taxable income. However, if such incentives are provided at the initial stages of a business, the incentive may be declared as capital, and is therefore voided of tax. Incentives in the form of reduced rent and entertainment incentives, such as holiday packages, are also spared from being taxed.
Repayment clauses
One of the most important reasons as to why tenants must study the lease agreement before signing is due to the repayment clauses that are indicated in the contract. In some cases, a sub-clause is included which requires tenants to repay an identified portion of the incentives in the occasion of assigned, surrendered, or terminated agreement before the lease expiration.
Fit-out ownership
Tenants must clarify ownership mechanisms of the agreement when it comes to fit-out, especially when specifying the roles and duties of both parties in fit-out taxation and ownership, particularly in the event of lease expiration.
Incentive disclosure
Finally, never hesitate to employ professional help to carefully examine the inclusions and exclusions of lease agreements and in negotiating for better terms.
As cliché as it may sound, it is indeed better to be safe than sorry. After all, a lease agreement is a legal document, and your signature binds you and the landlord to the law. These incentives are nevertheless enticing, but never let that spur of excitement lead you to sign an agreement without careful consideration, which might lead you to undesirable consequences and loss in the long run.
Even after outlining all the information above, knowing your commercial lease incentives when leasing CRE can still seem daunting. That’s why the Leveraged CRE Team at Commercial Properties, Inc. is here to help you achieve your business and leasing goals. Contact us at (480) 330-8897 or send us an email at request@leveragedcre.com.
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Phill Tomlinson is a commercial real estate broker with Commercial Properties, Inc. (CPI) in Scottsdale, Arizona, and owner of the Leveraged CRE Investment Team specializing in investment sales and tenant/landlord representation in the Phoenix and Scottsdale submarkets. Phill applies over 21 years of experience in the Real Estate industry helping investors and owners maximize their returns.
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