Rent abatement allows a business tenant to withhold rent payments to their landlord. If the property is unusable, the Tenant may make a rent abatement request. Sometimes called “free rent,” rent abatement allows a business to conserve cash.
Landlords offer free rent to Tenants at the beginning of a commercial lease. In this case, it is often an incentive to sign the lease.
Rent abatement is a common commercial lease provision. Because of this, it is something a Tenant should often request. If you are a business owner, you will want to negotiate the terms in your favor. If you are a landlord, offering free rent can get a Tenant to sign your lease.
You will know the rent abatement terms by defining them in your lease. Rent abatement benefits the Tenant. Because of this, Landlords are careful to word this section of the lease.
You should include a rent abatement clause in your lease for many reasons. Common reasons include water damage, fire damage, smoke damage, and significant broken glass. Other situations can cause a request for rent abatement as well. If some windows get broken, due to an accident or malicious behavior, it doesn’t mean you get free rent.
In most cases, the impediment needs to be so severe that the business owner can’t operate their business. Sometimes only severe impediments trigger the rent abatement. Other times, formulas determine the extent of negative business impact. If the damage is severe the Tenant should request rent abatement from their landlord.
One of the best times to consider using rent abatement is when it is free rent. In this scenario, a landlord offers a tenant free rent as an inducement to sign a lease with the property owner. For example, if a business owner is considering a 3-year lease, they may be able to get 1 or 2 months of “free rent.” If a tenant signs a 5 to a 10-year lease, they may be able to get 4-6 months or more in free rent.
The number one reason landlords offer free rent to Tenants is that they want you as a Tenant. Landlords use free rent as a way to induce business owners to sign their lease. Restaurants, bars, and medical users, among others, often make expensive improvements. Tenants can put their money into the improvements, instead of rent. These improvements often improve the owner’s property value. Many improvements stay with a property after the lease ends. The Landlord often receives an improved space in return for offering free rent early on.
“Free rent” also allows a landlord to keep the lease rate per square foot higher. After the free rent period is over, the monthly rent on the remaining lease period is higher. This increases the property’s net operating income or NOI. A higher NOI increases the value of the property. The tenant wins with free rent and the owner wins with higher building value. While a higher building value may increase taxes, it also increases the sales value. Higher equity ratios allow owners to refinance and redeploy capital to new projects.
Rent abatement, as a free rent incentive, is usually offered to high-quality tenants. Sometimes Landlords provide Tenants free rent when the economy is tough. With many choices available to business owners, Landlords need to entice Tenants.
What makes a business tenant appealing to property owners involves several factors. An older business is usually more appealing to a landlord than a new business. While property owners will offer free rent, they do expect to get paid back over the term of the lease. Businesses that have operated a long time have proven their success. A new business startup may not even last a year, so landlords want to be careful when offering free rent.
Rent abatement, as a free rent incentive, is usually offered on longer-term leases. This is because the longer-term offers a larger total lease value to the property owner. In some cases, you may even see free rent upfront exchanged for extra rent at the end of a lease. For example, if a business owner wants to sign a 5-year lease, a landlord may offer 3 months of free rent upfront. The owner may ask the business owner to sign a 5 year plus 3-month lease. In this way, the business gets 3 months of free rent to accommodate moving and build-out costs. The landlord still gets a full 5 years of lease income. Adding 3 months at the same location is usually easy to do. This is one way to create a win/win during lease negotiations.