What You Should Know About Lease Incentives

In a leasing transaction, it is common for a landlord to offer lease incentives to attract a potential tenant to their property. Some lease incentives are rent abatement, rent reduction and fit-out contribution. Either the lease or a separate deed will document the incentive. This article outlines the different types of lease incentives a landlord can offer you, as a tenant.

Rent Abatement

Rental abatement, also known as rent-free periods, is the suspension of rent that you, as the tenant, would otherwise pay at the start of the lease. Here, the landlord does not require you to pay rent for the premises until your business is up and running. The usual time frame is anywhere between one to three months.

This type of incentive can vary depending on the rental value of the property. Usually, smaller premises with low to average rent attract a rent-free period long enough to cover a fit-out period. For premises with higher rent, landlords give rent-free periods of six months to a year. For example, a commercial office with a large leasing footprint where the landlord wants to secure a good long-term tenant or large retail tenant.

Rent Reduction

A rent reduction is when the landlord spreads your rent across the lease term. In effect, this reduces the monthly rental payments under an agreed rent reduction schedule. You should note that if the lease contains a market rent review, you will not be able to take the rent reduction or rent-free period into account for the purpose of calculating the market rent.

Fit-out Contribution

Landlords sometimes give fit-out contributions as a lease incentive. This applies to the your fit-out works. A landlord can pay this contribution on a reimbursement basis, where you provide them with receipts showing the fit-out costs. Alternatively, the landlord may carry out the fit-out works under prior agreements to the value of the incentive amount.

If you elect for a fit-out contribution, you should know the trigger event for how the landlord will pay. It is a standard requirement that the landlord will not pay a fit-out contribution until you have:

• executed the lease;
• provided the security required under the lease. For example, a bank guarantee or security deposit;
• taken out the necessary insurance policies; and
• submitted the plans and specifications for the fit-out work for the landlord’s approval.

The landlord may require you to produce several quotes for the fit-out work. In this case, the landlord may decide to pay the cheapest quote provided.

Combined Incentive

A landlord may rely on any combination of rent abatement, rent reduction and fit-out contribution when offering a lease incentive to you. Commonly though, landlords offer their tenants a rent-free period to carry out their fit-out works and an additional incentive contribution.

Tax Implications

Landlords will often seek accounting advice when deciding which lease incentive to offer. This is because there are tax implications with each of the incentive methods described. For example, with fit-out contributions your landlord may claim to ‘own’ the fit-out as they are still paying for it. Consequently, you will not get any depreciation benefits from the fit-out even though the landlord requires you to remove the fit-out when the lease expires or terminates.

Clawback Provisions

Usually, the landlord will include a clawback or pay back provision in the lease or incentive deed requiring you to pay back the incentive amount if you ‘trigger’ a certain event. This event includes early termination of the lease due to a breach or an assignment of the lease.

As a tenant, you should carefully consider these clawback provisions. This is because they can have the effect of forcing you to serve out the full term of the lease. According to case law, clawback provisions are enforceable. However, you should seek legal advice when reviewing these types of provisions to ensure you do not face any surprises down the track.

Key Takeaways

In a competitive leasing market, landlords are eager to secure good tenants by offering incentive packages. As a tenant, it is important you understand the different types of lease incentives available, as well as the tax implications for each method. You should also seek legal assistance to ensure any clawback or pay back requirements are not onerous. If you have any questions, contact LegalVision’s commercial leasing lawyers on 1300 544 755 or fill out the form on this page.