Last Updated on March 29, 2023 by Morgan Beard
We are officially two years into the pandemic. So, now is as good a time as ever to review lease incentives. There are commercial real estate deals to be found in this market. And, while a great rent price is nice, a lease incentive in many ways is better. The bounce back of the office and retail markets may be tied to incentives from landlords.
Lease incentives are one way in which landlords can enhance the tenant experience. Especially, as organizations re-evaluate their real estate strategies. These should be top of mind for both office, retail, and restaurant occupiers.
Landlords may cringe at the term lease incentive. But, incentives are beneficial to both the tenant and landlord. For landlords, as opposed to dropping rent prices to entice a tenant, they can offer lease incentives. This keeps the landlord’s property value high (by not lowering rent and diminishing value) and optimizes for the tenant experience. So, let’s dive into lease incentive examples.
What are lease incentives?
In its essence, a lease incentive is an inducement to entice a lessee to sign a lease. A lease incentive is a cost to the landlord and a benefit to the tenant. That being said, the cost of the incentive should be figured into the deal over the complete duration of the lease. The most common type of lease incentive is a Tenant Improvement Allowance (TI Allowance). And this particular lease incentive often adds value to the space.
Common lease incentives examples:
Tenant Improvement (TI) Allowances
A tenant improvement allowance is a lump sum of cash to renovate a given space. These can be either soft or hard improvements. Hard improvements could include construction projects like new flooring, windows, doors, plumbing or HVAC upgrades. An example of soft costs may include project management fees from architectural designs to construction labor costs. Some site build out costs that are typically not included in the TI allowance include IT equipment, furniture and fixtures. The given tenant improvement allowance amount ranges depending on the renovation plans.
Rent Free Period
A rent free period is a duration of time in which you, the tenant, are off the hook on rent payments. It typically occurs at the beginning of a lease agreement as a way to sweeten the deal for the tenant. Rent free periods are great for retail and restaurant tenants who need time to get their business up-and-running in order to generate cash flow.
A rent abatement is a reduction in monthly rent due. It can be represented over a set duration or full duration of the lease term. It is typically a percentage or dollar discount.
Some commercial real estate buildings include a parking lot for employees or patrons. Free parking is an excellent way to entice tenants.
Moving Expense Reimbursements
For any organization, moving office space or relocating your retail space includes a moving expense. The cost of movers and time lost in business activities can be negotiated into your lease as a moving expense reimbursement.
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Planning for growth: Tips for negotiating your lease
Lease incentives should be included in your overall lease management strategy. Many times these are the make or break factor for either the tenant or landlord during negotiations. It’s important to have an understanding of your must-haves vs. nice-to-haves.
Here are a few tips & tricks for tenants to keep in mind when negotiating lease incentives in their lease deal:
Know your business needs – Which incentives are most important?
If you are an office occupier looking to add space for your employees, then then the tenant-improvement allowance may make the most sense. Especially, as employees expect a modern, tech-enabled office location. Tenant Experience is top of mind for many office occupiers as they rethink their corporate real estate strategy.
If you are opening up a new retail location or restaurant location, then having a rent-free period or rent abatement is critical to assist with cash flow. One example of this could be a restauranteur opening their first ghost kitchen and launching a virtual food and beverage brand. Having cash on hand as your kickstart the brand may be mission critical to the business’s success.
Research Comps in the area
In order to position yourself for negotiation success, collect the necessary market data points. Gain knowledge of other deals, lease incentives and rent comps in the area. Research the landlord’s real estate portfolio and find which incentives are motivating factors for the landlord as well. Use a transaction management tool to assist you in this process.
Work with a Tenant-Rep Broker
One tenant-rep brokerage firm in Australia found that partnering with a broker saved the tenant 22% during the lifetime of their lease term. We suggest partnering with a local tenant-rep broker who knows the area and the comps. They are your go-to advisor and strategist for getting you, the tenant, an equitable deal.
Accounting for lease incentives
Accounting for lease incentives under ASC 842 warrants an entirely separate blog post. That being said, it is worth noting that lease incentives do complicate the lease accounting process. For instance, under ASC 842 when the lease incentive is paid up-front, the opening lease liability is unaffected. But, the opening balance of the ROU asset should be reduced by the amount of the incentive.
On the other end of the spectrum, if the lease incentive will be paid in the future then both the lease liability and the right of use asset are affected. So in order to account for future lease incentive payments, the lessee will need to subtract the lease incentives from the upcoming lease payments. And, opening balance of the lease liability and the right of use asset will be the present value of the scheduled lease payments. We have a full blog post dedicated to Accounting for lease incentives under ASC 842.