Let’s incentivise to save face! Landlord incentives for tenants
Most of you, as franchisors enter into leases of premises. In an era where landlords want to maintain the appearance of healthy face rents and attract tenants in a struggling retail environment, it is now a given that landlords will offer incentives.
What are incentives?
Incentives are a benefit offered by landlords to tenants when entering into leases. They are a sum of money and can take various forms (in any one transaction one or combination of):
- Contribution to fit out
- Reduction in rent
- Amortised discount in rent.
This isn’t a common form of incentive and, even if it is on offer, you need to consider the tax implications of this. Will it be income taxed in your hand?
Contribution to fit out
This is a more common incentive with the landlord contributing towards your fit out. The big issue I see often is around timing of payment. Will the landlord pay instalments – say, an initial sum when documents are signed, deposits paid, insurances given, security provided and work is started, then more when work is finished and a final amount when you commence trade? You need to be careful that the lease allows the landlord to pay your contractors directly. The landlord will also want to obtain the benefit of depreciation of the fit out and will usually require a selection of items of fit out – I like to call this depreciation schedule a shopping list!
Reduction in rent
You may take your incentive in the form of a rent reduction. Say if your incentive is $100,000 – you may elect to not pay rent until you have used up your incentive so, if your monthly rent is $10,000, you wouldn’t pay rent for the first 10 months. In other words, you’re given a rent free period.
Amortised discount in rent
Some tenants may choose to take their incentive over the term of the lease. Using the same example of $100,000, you may decide to spread that $100,000 across the full term of the lease so that each monthly instalment of rent is discounted.
Beware the hidden traps
Read the fine print carefully. Can your incentive be clawed back? The landlord may say that if you assign your lease or give up occupation (say if you licence or sublease to your franchisee) or change the control of your company, you have to pay back your incentive or it may cease. Try to negotiate limits to the crawl back – like a sliding scale which means less of the incentive is clawed back the longer the term of the lease so that 100% would be repayable in the first year and zero at the end of the term; or you may limit any claw back to the first three years (where you have a five year term) - or to not apply at all where you sub-lease or licence to a franchisee, assign to a related party or there is a change in control. This is a big issue that I see repeatedly during lease negotiations.
Another hidden trap is including the incentive in any market review. Most leases I review, will have a market review upon exercise of option. You need to read the criteria that is included in the lease for a market review. Often, any incentives given to the tenant for the particular lease or any incentives offered in the market place are excluded from a market assessment. I advise my clients to try and have incentives included because face rents look really healthy but are often masked by generous incentives.
Also, make sure that the incentive is transferrable – to your assignee of your lease and to any person who buys the premises off your landlord. Landlords often object to the right for you to assign your incentive to any assignee of the lease and will say they have given the incentive to you only. Quite frankly, this argument doesn’t stack up. If your assignee meets the criteria for assignment (which means they will have been assessed and approved by the landlord) why shouldn’t they be assigned the benefit of the incentive – particularly involving a rental discount over a longer term! In addition, you need to make sure the lease documentation clearly says that the landlord must procure that any incentive being paid to you must be honoured by any party who buys the premises – otherwise once the premises is sold your new landlord won’t need to pay the incentive leaving you to recover it from your original landlord.
The message in all this is that an incentive is a valuable commodity – it enables landlords to attract tenants so as to trade off a higher face rent. However, for you franchising tenants out there, look carefully at the form it will take and the hidden traps!
If you have any questions regarding your incentives, please contact:
Andrew Grima, Principal
Phone: +61 2 9895 9271