Commercial lease incentives are payments or concessions on lease terms that landlords may offer to induce new or existing tenants to sign or renew a lease. The COVID pandemic has unfortunately caused a rise in commercial property vacancy rates, as businesses have been forced to shut down due to economic conditions, while many employers have sought to reduce their office footprints after adopting work-from-home or hybrid models for their employees. As a result, commercial lease incentives are becoming an important issue in many commercial lease negotiations.
How Commercial Lease Incentives Affect Rental Rates
A commercial lease incentive allows a landlord to adjust rental rates for tenants based on market conditions. When a commercial lease includes incentives, it effectively creates two types of rent: “face rent” and “effective rent.” Effective rent refers to the rent figure after the commercial lease incentives have been applied – that is, the money that the tenant actually pays to the landlord. Face rent is the rent figure listed on the lease, which does not incorporate the value of the commercial lease incentives.
Why Commercial Lease Incentives Are Important in a Post-COVID World
Landlords often use commercial lease incentives to compete with one another and to maintain property occupancy rates. Commercial landlords want to avoid high vacancy rates, which can cause cash-flow problems, create difficulties selling or securing financing on a property, or may trigger existing tenants’ early termination rights. Commercial landlords may also prefer offering commercial lease incentives rather than simply agreeing to a lower rent because it keeps face rents higher, which protects the property’s appreciation. Commercial property is considered a good investment if the property’s value continues to climb, which makes face rents important for landlords.
In a post-COVID world, commercial lease incentives will be an important way for landlords to attract and retain tenants and keep occupancy rates up. With increasing vacancy in commercial spaces due to COVID, tenants know that they have options. However, commercial landlords also do not want to jeopardize their property values by agreeing to lower face rents to attract tenants. Therefore, commercial lease incentives enable landlords to offer effective rents in line with current market conditions while preserving face rent values.
Types of Commercial Lease Incentives
Examples of commonly employed commercial lease incentives include:
- Rent-free periods, typically one or more months (usually at the beginning of the lease term) in which the tenant does not pay any rent, are often used when new tenants need time to start generating cash flow or if space requires substantial fit-out.
- Rent abatement or reduction, which is a dollar or percentage discount on the rent spread out over part of or all the lease term. Landlords may prefer abatements since they spread the incentive out over the lease term rather than putting it at the front of the lease as in a rent-free period.
- Fit-out contributions reimburse a tenant for some of or all their fit-out costs. However, you should negotiate with your tenant whether you will take ownership of part or all the fit-out once completed, as well as when and under what conditions fit-out contribution payments will be made to the tenant (e.g., will you directly pay contractor invoices or simply reimburse the tenant).
Contact Us for Experienced Legal Advice in Negotiating Lease Incentives with Your Tenants
If you are negotiating a new lease or lease renewal with commercial tenants, reach out to Telpner Peterson Law Firm, LLP for a consultation to speak to an experienced Council Bluffs real estate attorney from our firm. We can help you better understand commercial lease incentives and how you might use them for your commercial property.