Incentives are essentially a tool used by building owners to entice businesses to lease space within their office properties.
Incentives are generally referred to and applied in various forms (as follows):
- Contribution towards construction of fit out;
- Contribution towards amendments to fit out;
- Abatement of rent across part or all of the lease term;
- Upfront rent-free periods;
- A combination of all of the above.
Incentive levels are dictated by the market conditions and will ebb and flow depending largely on prevailing vacancy rates and subsequently how competitive building owners believe they need to be in order to attract new tenants. For example, in Brisbane, where total vacancy has been well into double digits since around 2013, incentives are significant, whereas other capital cities such as Sydney and Melbourne overall vacancy rates are less than 6%, and incentive levels are much lower.
How is a lease incentive calculated?
Incentives are generally calculated as a product of the gross rent, tenancy NLA (sqm), and lease term. An example calculation may be:
30% Incentive (Total)
Rent x NLA x Lease Term
$625/sqm x 200sqm x 5yrs = $625,000
$625,000 x 30% = $187,500
In this circumstance, as the Tenant you would receive a total incentive pool of $187,500, generally available in one or more of the forms outlined above.
Your incentive and your fit out
If, in the instance you were required to construct a new fit out at, say, a cost of $800/sqm ($160,000), the residual that was not used towards fit out would subsequently be used to reduce the rent, typically spread evenly over the course of the lease. This would mean that the $27,500 not spent on fit out is divided up over the 5yrs, leaving $5,500 per annum plus GST (or $27.50/sqm) as a rental reduction.
Each building owner may have a slightly different approach as to how they wish to fund the fit out component so it is important to check what mechanisms are on offer.
Some building owners may be willing to contract and pay the fit out company directly (on an agreed payment schedule) subject to the Tenant approving the works, whereas other building owners may request the Tenant contract the fit out company, fund the fit out on the way through, and then reimburse them at the end. Either way the Landlord will generally seek to retain ownership of the fit out for depreciation purposes.
As incentives are a multiple of the lease term the shorter the lease term the smaller the overall incentive pool. To follow on from the above example, a 3yr lease would only generate $112,500 as a total incentive. The fit out remains fixed at $160,000, and therefore the Tenant would be required to tip in their own money to finish the fit out and would not preserve any incentive to be taken as abatement.
Another way a building owner may present their vacancies is by speculatively fitting a space – which means building a brand new fit out with no committed tenant. As money has been spent on these spec fit outs, a building owner will subtract the amount spent on fit out from the incentive pool they are willing to provide and, in turn, only give a smaller incentive amount to be taken as a rental reduction.
If you are able to identify a space that has a suitable existing fit out (recycled) you may be able to apply a much greater proportion of your incentive (sometimes all) as rental abatement. In this instance there may be some compromise around fit out design and quality but often the cost savings and ability to do shorter leases are of greater value to the Tenant.
Incentives are intricate and distributing the funds in the best way possible takes careful consideration with your business’s particular goals and budgeting in mind. All Caden agents are well versed in incentive structuring and can assist in ensuring you put your business in the best space for your needs.
