Your Commercial Lease's Rent Abatement Clause: What You Should Know

May 5, 2022 Don Catalano Don Catalano

Negotiating a free rent concession can be a clever way to reduce your effective rent. It can be a win-win for both the commercial tenant and landlord. 

 

How do we know this? As tenant reps, we help our corporate clients slash their rent costs every day.  A great tenant rep can take into account their client's needs, as well as understand what the landlord needs to achieve a deal that is optimum for the tenant. 

 

We will give you the basics of rent abatement and discuss the main factors that influence it, including:   

  1. What is rent abatement? 
  2. What does rent abatement cover? 
  3. Why do landlords offer rent abatement? 
  4. How long will rent abatement last?  
  5. When does rent abatement go into action? 
  6. Options tenants have when enacting their rent abatement   

 

What is Rent Abatement? 

Rent abatement is a period of free rent negotiated into your lease. It can occur during the first year of your lease or it may be spread out, at intervals, over your lease term. 

 

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Does Rent Abatement Cover Everything? 

No. Just because you aren’t making base rent payments doesn’t mean you’re off scot-free. You still may be on the hook for additional rent factors, including:  

 

Regardless, rent abatement is an excellent way for tenants to negotiate a lower effective rent. It also can help mitigate the cost of moving. 

 

Why Would a Landlord Agree to Free Rent?  

Landlords provide rent abatement as an inducement to get you to sign their lease. Depending on market dynamics and the skill of your tenant rep, landlords would rather secure a credit-worthy tenant than miss the opportunity to fill their space. 

 

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Rent abatements are also not as costly for landlords as other concessions. As a result, landlords may be more willing to offer rent abatement than out-of-pocket inducements like tenant improvement allowances.

 

Your tenant rep can rationalize with the landlord that offering you free rent is better than having vacant space.

 

While it is true the landlord isn't collecting rent for those months, they are covering the operating expenses. 

 

earning money

 

How Long Does Rent Abatement Last?  

The timeline of rent abatement is highly variable. Depending on the following factors it could range from one month to over a year: 

  • Current market supply vs demand 
  • The creditworthiness of the tenant 
  • The length of your lease’s term  
  • The vacancy within the target building and the landlord's portfolio 
  • Other concessions your landlord granted 

 

Since there are many factors affecting how much free rent you can achieve, an experienced tenant rep is key to negotiating a favorable package with a sophisticated landlord. However, one of the most influential factors is the length of your lease’s term. Your landlord’s willingness to offer free rent is contingent on your lease period. Landlords are more likely to offer longer rent abatement periods for longer leases. 

 

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Think about it from their perspective. Why would they be willing to give six months of free rent away on a three-year lease? The investment has to be worth it for them. A six-month rent abatement period would be more feasible for a ten-year lease.  

 

When Does Rent Abatement Start?

Traditionally, a rent abatement period will be utilized at the beginning of the tenant’s leasing term. 

 

However, the time for the landlord to build out your space must be accounted for. You want your free rent to start after the period in which the landlord has substantially completed your Tenant Improvements. Typically landlords will need 90-120 days to complete an office buildout. So you want your free rent to start after that period. 

 

For example, since many commercial spaces require renovations, a construction period should be accounted for. If the rent abatement period did start on your lease commencement date and not the occupancy date, you would use up some of your abatement period on construction. 

 

vanillla  shell

 

As a result, you could be responsible for rent payments as you move in (or even before) when you budgeted for several months of occupancy free.  

 

To achieve a full lease term, especially when considering amortizing the cost of your Tenant Improvement Allowance, landlords usually want to tack on the number of free months' rent to the lease term.  Thus a ten-year lease with ten months of free rent becomes a 130-month lease. You will still be paying ten years of rent payments. 

 

Also, according to the Financial Accounting Standards Board (FASB), you may need to amortize the savings from rent abatement over the term of your lease. Be sure to consult with your accountant, but you may not be able to initially write off first-year savings. Instead, they likely will have to appear over the length of your lease. 

 

Rent Abatement Options Tenants Have  

Tenants should be assessing how a rent abatement term at the beginning of their lease will influence its net value.

 

Though free rent is often front-loaded in the beginning of the lease, there are many ways to skin the cat.

 

This is especially true if your tenant rep is able to negotiate a big free rent package. The landlord may rightfully wish to start cash flow within that first year. Therefore, your tenant rep may negotiate some of the free rent at the beginning of the lease while the rest is spaced out over the term of the lease. This could make it a lot more palatable for your landlord. 

 

To understand the true financial impact of any free rent package, your tenant rep should provide you with a Discounted Cash Flow analysis (DCF). Key to having a DCF is picking the right discount rate. The advantage of the DCF is that it properly analyzes the Time Value of Money (TVM) of cash flows over the protracted period of your lease.  

 

For example, sophisticated tenants and skilled tenant reps know that tenants can:  

  • Front-load the free rent in the first year
  • Take one month’s abatement each year 
  • Split abatement between front-loading  and intervals 
  • Increase lease term to account for abatement period  

Landlords are savvy, but at the end of the day, they want your tenancy. A free rent package can help you achieve your goals while helping the landlord fill their space.

 

For example, payments lost to a rent abatement at the beginning of a lease are often tacked on to the end. These additional payments are then subjected to the compounding escalations of previous years. If you front-loaded the rent abatement and those months are tacked on to the backend of the lease, those final lease payments have escalated. But does that really cost you more? It depends.  

 

If the rate of inflation over the term of the lease was greater than the escalation rate, then no, you'd actually be paying the landlord back less in present value terms. If the average escalation rate was equal to the inflation rate it would be neutral. And,  if the rate of inflation was less than the escalation rate then you would be paying the landlord perhaps slightly more.

 

The huge caveat here is that no one knows what the average rate of inflation will be over a protracted period of time. Therefore, as long as you have a reasonable fixed rate escalation clause, we recommend not worrying about the free rent months being tacked on to the back of the lease.  

 

There will likely be financial implications depending on where the abatement is taken. Here is an example of how payments would appear different depending on whether the abatement is taken in year one or year five. 

 

rent abatemeent options

 

As you can see, the tenant finds themself in a more advantageous position when they are strategic about the positioning of their rent abatement period. 

total npv

 

Tenants can value more from their rent abatement by assessing their options rather than just implementing it at the beginning of their term. 

 

Why Rent Abatements Exist  

Overall, rent abatements can be a positive for both tenants and landlords. Landlords score a credit-worthy tenant for their vacant space, while tenants benefit from having a period of free rent on their books. In addition, it can be a great way for tenants to sustain positive cash flow upon entering a new lease.  

 

 

money in pocket

 

How a Tenant Rep Ensures that You Receive a Rent Abatement That Works for You  

A tenant rep knows what can typically be achieved with your prospective landlord, considerimg current market supply vs demand dynamics.  They know how to structure the free rent package to be beneficial for you and palatable for the landlord. 

 

They have overseen countless commercial real estate deals and have negotiated rent abatement for their clients. They know how to analyze all the factors outlined in the lease and even the ones that may be omitted.  

 

They are also experienced in securing tenants the leases that benefit them most. Rent abatement is a critical aspect of this achievement. Your rep will be able to assess when you should enact your abatement, how long a period you should be receiving, and other steps to take to ensure you receive the maximum benefit.  

 

Check out this article to learn more about the benefits of working with a tenant rep!

 

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