New Lease and Lease Renewal
Let’s have a look at the world of lease incentives and what you need to know to get the very best out of your commercial real estate investment.
A few key considerations about incentives regardless of whether it is a new lease or a renewal. Before deciding what incentive type and structure for your property, do your research! This does not need to be an exhaustive process, just ask some questions of your managing agent or industry contacts/figures. The question only need be as simple as “What deals are you aware that have recently been done and what incentives were offered?”
Regardless of whether you are trying to attract a new tenant or renew a sitting tenant, having market driven information will ensure that you are not offering too little, and missing great tenants or offering far more than is required and leaving too much in the deal. As a rule, being more generous than less is recommended because a small amount of additional generosity may pay off if a higher quality tenant is secured or retained as a result.
Incentive Type and Structure: Some of the most common incentives are a rent free period, fit out contribution, relocation/moving allowances and promotional budget (or a combination of two or more of these).
The amount of incentive will vary based on the asset type and the motivation of the owner to attract the right tenant to their asset. As an example, it is not uncommon for shopping centre retail owners to offer incentives in excess of 20% of the total rent payable over the first term of a new lease. By contrast, large industrial sheds my see incentives of 5% or less particularly in areas where the demand is strong from prospective tenants.
One of the main factors is the set up or pre-operation costs for the business that will occupy your property. In the retail context, it is very likely that your tenant will have a significant fit-out cost and as such may not be in a position to start the business or open a new location without the large incentive due to a lack of capital. Compare this with an industrial shed that may be used for warehousing or storage where the fit-out costs are comparatively quite low.
It is also worth noting that the priority for the two business types is quite different: for the retailer, a great location and a flashy shop will have a direct impact on the success of business and they are prepared to pay a much higher price for this. In contrast, the business that occupies a large industrial shed will care more about having the space they need at the best possible price.
New Lease V Lease Renewal:This is best addressed in two parts.
Part One: Incentives to attract a new tenant to a vacant property
The incentive offered here will generally be more generous, the idea behind this is that whilst the property is vacant, the investment is not generating the owner any income so short-term cost for what will hopefully be a long term benefit in the overall strategy. The ideal situation with offering a healthy incentive to attract the right tenant is that the incentive support allows the business to prosper, increasing the likelihood of them renewing past the initial term of the lease.
Part Two: Incentive to encourage the tenant to renew
Incentives to encourage tenants to renew are far less common and less costly than those required to attract a tenant to a vacant property. Where vacancy rates are low there may be no need to pay any incentive at all. Were vacancy rates are higher it is normal that unsolicited approaches from agents and other property owners are being made to sitting tenants to try and attract them away from there current location to somewhere that is currently vacant.
This does not mean that it is necessary for property owners to match the incentive being offered to the tenant to move but a token incentive to encourage them to stay is worth considering. The reason that the new lease incentive does not need to be matched is that the business is already established in a location and the costs of relocation are much higher than staying put and the upheaval caused to the business operations during a relocation can be significant.
The best was to reduce the risk of having the tenant tempted away from their current location is to communicate often with them to ensure that they are happy, and to have the renewal conversations with them well prior to the relevant notice or expiry dates. If an incentive is required it is best to ask the tenant what they need to further benefit and advance the business. This may be things like new signage, bathroom or common area renovation, general maintenance or refurbishment works. It may also be things as simple as a short rent-free period or rent rebate.
Your greatest asset whether renewing or attracting a new tenant will be your management and leasing team. A thorough and balanced approach to these discussions and negotiations as well as the appropriate promotion of the property is essential to achieving the best outcome.