In a leasing transaction, it’s common for a landlord to offer some form of lease incentive to entice a potential tenant, such as rent abatement, rent reduction or fit-out contribution. Either the lease or a separate deed will document the incentive. Below, we set out the different types of incentives offered so tenants can assess which one is appropriate for their business.
Rental abatement or more commonly, ‘rent-free periods’ is the suspension of rent that the tenant otherwise pays at the start of the lease.
Rent-free lease incentives can vary depending on the rental value of the property. Smaller premises with lower to average rent usually attract a rent-free period that is just long enough to cover a fit-out period. The landlord does not require the tenant to pay rent for the premises until the business is up and running. The usual time frame in this scenario is anywhere between one to three months.
Landlords usually give longer rent-free periods of six months to a year to premises with a higher rental. For example, commercial offices with a large leasing foot-print where the landlord is keen to secure a good long-term tenant or large retail tenants.
A rent reduction is when the landlord spreads the rental lease incentive over 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.
Landlords will give fit-out contributions as a lease incentive which will apply to the tenant’s fit-out works. The landlord can pay this contribution on a reimbursement basis where the tenant provides the landlord with receipts showng its fit-out costs. Or, the landlord carries out the fit-out works under prior agreements to the value of the incentive amount.
If a tenant elects for a fit-out contribution, they should know the trigger event for how the landlord will pay. It is standard requirement that the landlord will not pay a fit-out contribution until:
- The tenant executes the lease;
- The tenant provides the security required under the lease (commonly referred to as the bank guarantee or security deposit);
- The tenant takes out the necessary insurance policies; and
- The tenant has submitted the plans and specifications for the fit-out work for the landlord’s approval.
Sometimes, the landlord may require the tenant to produce several quotes for the fit-out work, and the landlord will only pay for the cheapest quote provided.
The landlord could also provide a lease incentive that combines any of the above methods. Landlords commonly offer tenants a rent-free period to carry out their fit-out works and then an additional incentive contribution.
There are tax implications with each lease incentive method, and we strongly advise you seek accounting advice when deciding which method to choose. For example, with fit-out contributions, the landlord may claim to “own” the fit-out as they are still paying for it. Consequently, the tenant will not get any depreciation benefits from the fit-out even though the landlord will require them to remove the fit-out when the lease expires or terminates.
The landlord will commonly draft a clawback or pay back provision in the lease or incentive deed that requires the tenant to pay back the incentive amount if the tenant triggers certain events. These events include early termination of the lease due to a breach or an assignment of the lease.
It is important to consider these clawback provisions as they can have the effect of forcing the tenant to serve out its full lease term. A recent case, GWC Property Group Pty Ltd v Higginson and Others  QSC 264 has thrown into doubt whether a clawback provision is even enforceable.
If a clawback provision has the effect of penalising the tenant, the court has held that this is unconscionable in comparison with the maximum loss that the landlord may suffer from the tenant exiting the lease. It’s important to seek legal advice to review the incentive provision in detail to ensure that you don’t face any nasty surprises down the track.
In a competitive leasing market, landlords are eager to secure good tenants over an extended lease term by offering incentive packages. It’s important tenants carefully consider the different types of lease incentive options as well as the tax implications for each method. Finally, speak with a commercial leasing lawyer to ensure any pay back requirements are not onerous and do not limit your ability to deal with the lease down the track.
If you have any questions, or need assistance reviewing your lease documents, get in touch with our experienced commercial leasing team on 1300 544 755.