Lease incentives
Lease incentives are benefits a landlord gives a tenant to get a lease signed or extended, without lowering the quoted price per square metre. The most common ones are rent-free periods (a spell at the start of the lease with no rent), stepped rent (lower rent in the first few years, rising over time), and contributions to tenant fit-out (the landlord pays for adapting the premises). What they have in common is that they cut the tenant's real cost while the nominal rent in the lease stays high.
The reason landlords prefer incentives to a rent reduction is that the nominal rent is what the market and buyers see. Valuation of commercial property starts from the contract rent, and a high quoted rent gives a higher value through the yield method, even if the landlord has given away several months of rent in a rent-free period. That is why the gap between nominal rent (the figure in the lease) and effective rent (what the landlord actually keeps over the whole lease term after incentives) is one of the most important things a buyer has to work out. Two buildings with the same quoted rent can have very different effective rents if one of them has given away large incentives.
For an agent or manager preparing a sale or a letting, incentives matter in both directions. In a letting, they are a tool for filling vacant space in a market with a surplus of premises, or for landing a solid anchor tenant that lifts the whole building. In a sale, the incentives must be disclosed, because a buyer will adjust for them in due diligence: remaining rent-free periods and step-up periods reduce the cash flow in the first few years, and with it the price. Incentives also affect WAULT considerations, because a long lease bought with large incentives is not as valuable as a long lease at full market rent.
Incentives must be kept separate from CPI indexation, which is the annual inflation adjustment of the rent, and from a rental guarantee, where a third party or the seller guarantees rental income for vacant space for a period. Incentives are a discount the landlord gives itself; a guarantee is security for income that does not yet exist.
From Placepoint's glossary: Lease incentives
More information: Store norske leksikon: leiekontrakt
English: Lease incentives (rent-free periods, stepped rent, fit-out contributions).
Common questions
What are lease incentives?
Lease incentives are benefits the landlord gives to get a lease signed or extended without lowering the quoted price per square metre. The most common ones are rent-free periods, stepped rent and contributions to tenant fit-out.
What is the difference between nominal and effective rent?
Nominal rent is the amount stated in the lease. Effective rent is what the landlord actually keeps over the whole lease term once incentives such as rent-free periods and stepped rent are deducted. The difference can be large.
Why do landlords give incentives instead of lowering the rent?
Because the nominal rent is what the market and buyers see. The valuation is based on the contract rent, so a high quoted rent gives a higher value through the yield method, even if the landlord has given away rent in a rent-free period.
How do incentives affect a property purchase?
A buyer adjusts for the incentives in due diligence. Remaining rent-free periods and step-up periods reduce the cash flow in the first few years, and with it the price. They also affect WAULT, because a long lease bought with large incentives is worth less than one at full market rent.