Lowering prices on commercial real estate rents is usually a not-so-welcome decision for landlords, property owners and investors. Still, even the strongest markets at the height of the real estate cycle can’t remain that way forever, and when the downturn comes, you’ll need a plan to protect your investment, keep at least some profits flowing and ensure your property doesn’t sit vacant while you wait for the market to improve.
If you’re struggling to find tenants for your commercial property, and are at risk of not meeting your occupancy rate, rent concessions, also called rental concessions, can make your property more attractive to potential tenants when there’s more supply than demand. Here’s what you need to know before offering them.
What Is a Rent Concession?
“A rent concession is essentially an adjustment by a property manager or a landlord owner of a building, which makes the lease terms more attractive to the tenant or prospective tenant,” Ethan Freilich, a Financing Expert at Lev, told leverage.com.
Investors, property owners and landlords usually offer rental concessions in a sluggish market, when the longer a property or unit stays vacant, the more rental income they lose.
2020 was an example of one of those markets. During COVID, many tenants were unable to make their rent payments. To keep current tenants and attract potential tenants, “[some] landlords offered rent concessions to pay reduced rent until a certain date or they offered three months free rent and then began charging full rent,” Ofir Shalom, a Financial Expert at Lev, told leverage.com. “As opposed to [having] the entire property being 10-20% occupied with two tenants paying full rent, they were able to maintain occupancy levels at 50-60% and have 10 tenants in the building (for example).”
Rental concessions fall into three main categories, two of which are offered by landlords to tenants, and one that’s offered by lenders to investors or landlords. Get familiar with these if you’re a first-time landlord or investor. Then we’ll review examples of popular options to choose from within those categories.
Lease-up concessions are offered either at the start of a leasing period for new tenants or for existing tenants. The goal is to attract tenants as quickly as possible to meet occupancy goals and expedite profits.
Reference this one for older, newly renovated, or otherwise improved commercial buildings. The strategy, as Apartments.com contributor Jamia Kenan explained, “is to market the property slightly above the average market rent rates, so the concession appears to bring the rate in line with the rest of the market.” If you choose this route however, make sure your property is largely occupied, that the renovations are extensive enough to attract new potential tenants, and that the advertised price is only a little above the market rent for similar properties.
Red Flag Concessions
This rental concession applies to investors or landlords acquiring commercial real estate. If a lender is offering extensive concessions on loan or refinancing terms for a rental property to keep it occupied, these bargains may be a sign of larger problems with the physical or financial condition of that property.
The 8 Most Popular Commercial Rent Concessions
Concessions usually come in the form of discounts, rebates, goods and services (like access to amenities), monetary compensation or non-monetary adjustments to lease terms. The options vary depending on what type of property you have, whether it’s office space, retail or residential space, how flexible you’re willing to be on lease terms, and what kind of amenities are available.
Here are eight examples to consider:
- Rebates: Offering money back to tenants after an initial payment
- Discounts: Offering the first month free, or a reduced rent for an agreed-upon period
- Waived or reduced fees: This can apply to security deposits, pet fees, move in-fees, etc.
- Free utilities: Some landlords cover electricity, heat, hot water and/or internet
- Free use of on-site amenities: if your property has a gym, pool, business center, or similar features, you might considering offering free uses or discounted memberships for tenants as part of a rent concession
- New appliances or other space improvements
- Adjustments to lease terms: Allowing tenants to paint their walls or make small renovations without extensive fees, offering consent to sublease, shorter leases, longer single-tenant net leases, protection against rent increases, or similar compromises
- Paying the broker’s fee
Pros and Cons of Rent Concessions
Before you start slashing prices and offering free gym memberships, consider the advantages and disadvantages of rent concessions and plan accordingly.
- They incentivize new tenants to sign leases in a down market
- They also encourage existing tenants to stay, and, as Kenan pointed out, “Resident retention is one of the best ways to keep your rental property profitable.”
- Helps landlords maintain at least some level of profit compared to no profit for a property or unit with a long vacancy
- They set landlords up for a stronger future, with fewer vacant units for them, fewer options for tenants who might be tempted to leave, and hopefully higher rental prices in the future.
- Even if they’re necessary and temporary, concessions mean losing money and potentially credibility with lenders. Shalom explained, “Landlords may need to cover more costs by paying out of pocket for operating expenses. This also affects the overall value of the property, which affects how much of a loan a landlord can get from a lender.”
- They can be hard to take away. Even if tenants know the concessions are designed to be temporary, it’s easy for tenants to get used to rent discounts, free utilities, access to amenities, or other perks that made them want to sign the lease. Make sure tenants are clear on how long they can expect concessions, and what happens when they’re over.
- Decreased rent also means a decrease in funds to pay for property damage, late rent or other unforeseen circumstances. The chances of this happening decrease with detailed tenant screening, but it’s still worth considering.
When Should You Offer Rent Concessions?
“A lot of times you’ll see rent concessions happen before leasing starts,” Freilich said, giving the example of a landlord with a 10-unit multifamily building, with at least one of those units sitting vacant. “No one’s living there and [the landlord] wants to get another tenant to come in. So he might offer a rent concession, which could be one month of free rent to incentivize and attract potential tenants into the property.”
While particularly popular during lease-up, concessions aren’t only for new tenants, or even for residential buildings. For example, let’s say you have a hypothetical office tenant with a 10-year lease. They pay on time, have been painless to work with, and you’d rather they stay longer than look for a new one. You can also use one of the above concessions as a way to incentivize this hypothetical tenant to renew or extend the term of their existing lease.
Offer Concessions Now to Protect Your Profits Later
If you’re facing a surplus of empty units and not enough people to fill them, it may be time to consider concessions. As long as the money lost from a rent concession is less than the cost of a vacancy, it’s worth it to try a concession to decrease your vacancy rate. If you can ride out the down market with a mostly leased building, you’ll be in a much better place when the economy improves.