Free rent, or rent abatement, is a common and widely used concession in many commercial office leasing and residential property transactions. Landlords are offering free rent to entice tenants to sign leases and to assist with economic hardships that their tenants might face. And it’s almost exactly what it sounds like: rent that you don’t have to pay, but how does it work? Who really benefits? Are there pitfalls to consider?
The benefit of free rent for landlords is that it drives business. Many urban areas have seen people leaving amidst the pandemic and many businesses closing. Major benefits of free rent for tenants include saving money and overall satisfaction. Another benefit is also finding places tenants might not have been able to afford beforehand, offering free rent can significantly reduce the burden of cost for some tenants.
Offering your tenant free rent is not the same as offering a free ride. Free rent can be a great incentive to attract businesses while still maintaining your cash flow and business viability. It can show a property as being occupied to draw other prospective tenants. It can help a newly established, but promising, business to get on its feet; thus, ensuring a future positive and profitable relationship. Free rent can be a competitive advantage when enticing tenants to use your property, as opposed to other properties. It can also maintain property values by having a higher rent profile on the books so as not to devalue the total property.
Think of free rent as being similar to tax abatement policies used by cities to attract new business. This tactic has proved very successful for multiple cities around the country. Similarly, it has proven successful for many property owners and landlords. Not only can they give you the competitive edge, but you can place requirements on them such as length of lease and operating expense reimbursements.
Are there drawbacks to free rent (rent abatement)? Certainly. When offering a rent abatement, property owners should make sure that the discount will not cut into their ongoing property expenses such as: Common Area Maintenance (CAM); property taxes; maintenance fees and insurance. You don’t want your enticement to lead you into the red, so ensure that the tenant is still responsible for their pro rata share of the operating cost, even if they have a gross lease.. Furthermore, while it may be advantageous to offer such incentives to promising growing businesses, offering discounts to struggling businesses without clear plans for their growth can be disastrous — both for you and the business, which may have unrealistic expectations about its ability to grow. In fairness to your tenant, it is advisable that they make sure their sales will support the arrangement. Tracking tenant’s sales can be difficult, but with RAAMP’s tenant portal, tenants can report their sales and you as the landlord can monitor their sales performance easily.
In spite of the name, free rent does not have to be free. It is not intended to take money out of your pocket. It is a tool that can be used to attract a new business and be the start of a promising relationship. It can be structured in many ways so as not to make it financially disadvantageous for the landlord. Any potential financial losses, or cash flow issues, can be recouped through the structure of the lease by clearly defining the exceptions to the free rent and the tenant’s obligations under the lease..
A gross lease and a net lease are two different lease structure landlords can use for their tenants. A gross lease often include all operating expenses in the rent, so the tenant just pays one lump sum per month. A net lease usually doesn’t include operating expenses as part of the rent agreement, so the base rent is lower, but the tenant is expected to pay the additional operating expenses separately.
Consider offering free rent while adding in the lost value over the course of the lease (I.E., a higher rent than the market value to offset the initial discount). Another option is to extend the length of the lease so that the property owner is ensured to recover income over the life of the agreement. This could help extend the relationship between the property owner and the tenant. The lease should also be structured to include tenant-responsible expenses that the landlord would otherwise assume a gross lease or net lease.
To remain competitive in today’s real estate market, property owners must make use of all the tools in their toolbox. Think of free rent, or rent abatement, as one such tool. It is similar to those used across industries: coupons, discounts, even tax abatement.