What landlords and tenants must know about commercial rental incentives

So, you are a landlord. You’ve got a downtown office space you’ve been struggling to fill, but you don’t want to lower the rent and lose out over the long term. You look across the road and see the office there has just been filled - for an even higher asking price. How did they do it?

The likely answer: rental incentives.

But before you go leaping into offering incentives (or asking, if you’re a tenant), there are a few things to consider. Rental incentives and their calculations are a commonly misunderstood area of commercial renting, yet one that greatly affects both sides of the deal.

Logan Holyoake provides some insight into how these calculations work, and what both landlords and tenants need to know about rental incentives in today’s commercial property market.

Common rental incentives for commercial properties

The most common rental incentives we currently see around Auckland’s commercial properties are:

• Rent-free months (e.g. first 1-1.5 months of each year)
• A cash payment at the start of the lease (e.g. to help toward fit out)

The amount of incentive offered varies from situation to situation, but is usually associated with the length of the lease term. For example, you might be offered 1.5 rent-free months per 12 month term, which over a two-year lease is three months free in total, versus 15 months free if you’re on a 10-year lease. Sometimes you are offered the rent free up front, others each year of a lease.

Cash payments can be persuasive for tenants who are cash poor but need office space, such as startups or rapidly growing companies. The money up front can help them pay for fit-out, new desks, or whatever furnishings they require, but landlords must be confident that the amount they offer will be recouped over the term of the lease in the form of rent, and that the tenant is financially sound.

At the moment, we’re seeing these incentives increase as a result of COVID-19. Landlords want to keep getting the same or a higher rent per square metre, so they’re willing to offer tenants more incentive in exchange for this. In Auckland there hasn’t been a decrease in office rental prices, but there has been an increase in what incentives landlords are willing to offer to get tenants in.

While this difference has been evident in Auckland’s office market, the trend may not be as distinct elsewhere within the commercial and industrial property sector or around the country. This is where the knowledge of a local property valuer is vital to help you understand what’s happening in your region and industry.

How can you calculate for incentives?

Every commercial property has a base rental rate, which is the annual rent that has been agreed between landlord and tenant, often called the face rent.

On top of that, there could be incentives offered or negotiated in the form of either rent-free months or cash payments, to help close the deal.

When the financial value of these incentives is taken into account, you are left with a net effective rent, which is the total rental value that the tenant pays and the landlord receives.

Information about what incentives are on offer, or have been offered in nearby and comparable premises, are not readily available - it’s something we have to understand within our market. We spend a fair bit of time finding out what’s available, so we can provide an accurate rental value assessment for our clients.

What to know if you’re a landlord

When you’re a landlord wondering what to charge as rent for a new tenant in your premises, you need to have a full understanding of what’s happening in the market to ensure that you are simultaneously competitive enough and charging enough.

You’ll need to consider what, if any, incentives you will offer and how these can be calculated to ensure that you’re still receiving the rental payments you need to provide a market return after the incentive has been factored into the deal.

When you work with us, we’ll provide you with two figures: the base rental, which is the advertised face rate, and the net effective rental, which takes into account any rent-free period or cash incentive.

Overall, we’re looking to provide the best advice to our clients. Doing your calculations incorrectly or being ignorant of market needs can lead to a real underestimation of how much you need to balance both sides of the deal - and could pose a real risk to the landlord’s return.

This risk becomes reality when a landlord is already offering a net effective rent to their tenants, and then offers cash incentives on top. In this case, they’d effectively be discounting their own rental and taking lower than market rates.

Landlords must consider how much they need to give away in order to entice the tenant in, while still keeping effective rent at an acceptable market rate.

What to know if you’re a tenant

For tenants, the most important thing is ensuring you’re comparing apples with apples. Taking rental prices at face value can be a disadvantage because you could be comparing two very different things.

What incentives are on offer, and what value would these have for your business over the short and long term? Is there space to negotiate for incentives, if they’re not offered at all?

It’s important for tenants to calculate the effective value of a rental in order to be sure they’re getting the best structured deal for their business needs, at a fair market price.

Our valuers can provide advisory opinions on what sort of contributions we’re seeing from landlords in the market, and offer guidance in negotiating incentives.

Calculating the right value for you

As property valuers, our job is to take into account as much as possible about a premise, price, and incentive, to work out the most accurate reading of its value. This way, our landlords can be sure they’re not offering too much, and our tenants can be confident they’re getting a competitive offer.

When we’re working out a rental assessment or a market value, we’re always trying to create an even scorecard where all of the differences can be plainly seen and compared for what they are.

The outcome is a consistent market value that accounts for all variables - what’s offered, when it’s offered, and the duration of the lease - to understand the total value on the table for both landlord and tenant.

Whether you’re looking to fill the lease on your commercial rental property or compare the value of offers as a tenant, we’re experienced at figuring out the calculations as we work with a wide range of clients across all sectors and regions of New Zealand.

Get in touch with a valuer today

This article was originally published by TelferYoung