Rent abatement in a commercial lease means that the tenant does NOT have to pay rent for a certain time period during one of the following scenarios:
- During the initial tenant improvements,
- As a concession in lieu of a reduced rental rate,
- Or when the tenant is not able to occupy the space because major property repairs are needed.
1. Rent Abatement During Initial Tenant Improvements
Sometimes when you lease commercial real estate (e.g. retail space) the space is either in shell condition (brand new) or is 2nd generation space that needs a lot reconfiguration and improvements. Depending on the size of space, existing condition, and if a construction permit is required it could take anywhere from a few weeks to 6-9 months for any improvements to be completed.
Don't Pay Rent During the Build Out Period
In a commercial lease it would not make sense to have to pay rent during the construction period so it's important that you negotiate to receive rent abatement (free rent) during substantial completion of all the tenant improvements.
Example Rent Abatement Language in a Commercial Lease
In most cases landlords are fine with rent abatement during the construction period. Just make sure it's written in the lease. For Example: The rent commencement date shall be The earliest of (a) the date on which Tenant occupies any portion of the Premises and begins conducting business therein, (b) the date on which the Work (as defined in Exhibit D hereto) in the Premises is Substantially Completed (as defined in Exhibit D hereto), or (c) the date on which the Work in the Premises would have been Substantially Completed but for the occurrence of any Tenant Delay Days (as defined in Exhibit D hereto).
2. Rent Abatement as a Concession
When negotiating commercial leases you ask for all kinds of concessions such as tenant improvement allowance, lower rate, expansion options, etc. Rent abatement provisions (aka Free Rent) are also something that you can negotiate for.
Consider Landlord Investment Strategies
Investors that own buildings can have different investment objectives. Some prefer to cash flow a property and more likely to offer a lower rate. Others maybe trying to sell or refinance the building and more likely to offer free rent instead of a lower rate. You see the rents the landlords collects on a commercial property dictate the market value. The lower the rates the lower the potential value. It's important to understand the investment objective of each building owner as you negotiate the commercial lease.
Expect to Sign Longer Lease in Return for Rent Abatement
Anytime you can negotiate to get rent abatement in addition to a tenant improvement allowance and other concessions you will be better off in the long run. Keep in mind the more concessions you ask for the more extensive the background checks. Also a longer lease gives you a better bargaining tool during negotiations.
Also if you have negotiated effectively and are receiving rent abatement keep in mind at lease signing most landlords will still want you to write a check for the security deposit and pay rent for the first month. In that situation the check you write for the 1st months rent will be applied the first month AFTER your free rent period.
What happens if you get rent abatement and default on the lease?
Getting rent abatement can help you lower your overall monthly rent costs or help you pay for tenant improvements that are above and beyond what the landlord is willing to give an allowance for. However keep in mind in most cases if you default on rent payments or don't fulfill the entire lease term you will be required to pay back all or a portion of any rent abatement given. This is also known as a clawback provision. During negotiations if a landlord is going to demand a clawback in the event you default or break the lease try to negotiate to where you only pay for unamortized free rent. For example if you were given $12,000 in rent abatement and the lease term was 3 years it would be amortized over 36 months ($4,000 per year or $333 per month). If you broke the lease after the 12th month you would have to pay rent abatement you received back for the remaining 24 months or $8,000……..which is the unamortized portion.
Rent abatement on the base rent or NNN or Both?
Rent abatement is negotiable. If the landlord agrees to it they would rather just give you free base rents (aka net rent) and you pay the real estate operating expenses (taxes, insurance, maintenance). That way they are at least covering their building expenses.
As a tenant you would rather receive free gross rent (both net and opex). Do your best to negotiate this. In the end free net rent is better than nothing at all. In many cases in NNN leases especially retail and industrial spaces building owners prefer the tenants pay NNN during the free rent period.
3. Rent Abatement Due to Commercial Space Being Untenantable
In most commercial leases there is a Casualty clause (like in the example below) that talks about rent abatement in the event the tenant is not able to occupy or access a space because of fire or other casualty. It could be a partial rent abatement or full abatement depending on the scope of damage and what portion of the space the tenant has access to. Potential scenarios could be fire or flooding, natural disasters such as earthquakes, tornadoes, and hurricanes, or condemnation by the city or government. You can also try to negotiate rent abatement in the event of a force majeure such as act of God, shortages of labor, terrorist acts, governmental restrictions, etc.
Example Force Majeure Clause
If Tenant or Landlord are delayed or prevented from the fulfillment required under this Lease (other than paying Rent) because of lockouts, strikes, labor problems, unable to procure materials, power failure, acts of terrorism, insurrection, riots, failure to act or default of the other party, governmental moratorium, earthquake, fire, flood or other natural disaster, war or any other reason beyond the control of the party who is seeking additional time for the carrying out of such act (but excluding any delay due to its financial inability), then completion of this act shall be excused for the span of time that fulfillment is actually prevented that follows notice to the other party specifically describing the delay and the reason for the same. In such event, the time for the performance of any such act will be extended for a that time, in no event to exceed a term equivalent to the time of delay from and after such notice. No such interruption of any service to be provided by Landlord shall ever be deemed to be an eviction, actual or constructive, or disturbance of Tenant’s use and possession of the Premises or the Property
You May Need Business Interruption Insurance or Business Liability Insurance or Both
When leasing commercial spaces most landlords will want tenants to have business interruption insurance and/or business liability insurance.
Rationale Behind Rent Abatement
Commercial property owners typically have business liability insurance on their building. The insurance would cover any damages to the property in addition to abated rent. Personal property of a tenant that is damaged would be covered by the tenant's own insurance. It's a good idea for the tenant to have business interruption insurance as well to cover any potential financial losses. Since both parties have insurance – the tenant on personal property and the landlord on the property – the rent abatement puts the lease contract between landlord and tenant on hold until the property can be occupied again.
How Long Does the Abatement of Rent Continue?
The rent abatement last from the date of the casualty until the date the landlord has substantially completed the repairs and restoration. Rather than just let tenants out of a lease when a casualty occurs Landlords want the ability to try to cure the defects first within a certain time period (which is negotiated). The restoration could take weeks or months however at some point if the insurance company or contractors determine that the repairs will take longer than the negotiated time frame then the tenant or landlord could terminate the lease.
Tenants Must Negotiate to Not Let Rent Abatement Be Nullified
Tenants need to negotiate to require that no matter who caused the casualty the rent abatement provision will still exist. For example some landlords have language in the lease that says if the tenant or tenants employee causes the casualty then the abatement clause is nullified and the tenant must continue paying rent while repairs and restoration is being conducted.
Commercial rent is income for a landlord which is paid for by tenants. Part of the rent a tenant pays includes the building insurance coverage. If the abatement clause is nullified then the landlord is able to double dip by getting rent from the tenant and file the claim with their insurance company.
Free Rent is Negotiable
Rent abatement is a negotiable item in a commercial real estate lease that must not be overlooked. Not all landlords will agree to it however if you can get it you will save some money! Keep in mind, If you don't make an abatement request you will never get one.
Read the Fine Print
To ensure that you negotiate rent abatement effectively it's important that you read the fine print during commercial lease negotiations and consult with a real estate attorney and your commercial real estate agent because once the terms are finalized the clauses will be outlined in the rental contract and set in stone. Whatever happens after that will all be handled according to how the language is set forth in the contract.
How Landlords Respond to Abatement Requests
At the end of the day the landlord wants a good tenant paying rent and they are willing to give up a little money at the beginning of the lease to attract one. However when a tenant asks for rent abatement they will typically counter with a longer lease term, higher lease rate, higher yearly rent escalations, or some other concession. Also they most likely will not offer free rental payments on short term leases. In most cases a tenant would need to commit to at least a 3-5 year lease when abatement provisions are involved.
Every hear of the meaning of “bird in the hand is worth two in the bush”? Well if the landlord believes you are a strong credit tenant they would rather lock you into a deal giving you rent abatement then have the space sit empty for a few more months hoping a more credit worthy tenant comes along. In a competitive market and when there is a lot of interest on a space they are less likely to give it.
It never hurts to ask for rent abatement however keep the full scope of the deal in mind and be knowledgeable about the market. Negotiating intelligently will make the landlord respect you much more.
The next time you negotiate a commercial real estate lease you want to understand what the landlords motivation is. Are they trying to sell the building or not?
- If they are trying to sell the building and open to rent reduction then they may be more motivated to give free rent since that does not have a direct impact on the market value of the property.
- If they are not selling the building they may be cash flowing the property, meaning they maybe more motivated to offer a lease rate reduction.
- Understand that landlords want a great long term tenant with strong credit that pays rent on time, and they are willing to give up a little income at the beginning of a lease to attract one.
- Put yourself in a strong negotiating position by having your financials in order. Landlords like tenants with strong financials.
- Increase your leverage by having more than one space option on the table. If they know you don't have any other choices they won't be as negotiable.
- Start by asking for rent abatement on the base rents and NNN and see if the landlord budges. If they don't then get creative.
- Make intelligent offers, not low ball offers. Learn the market or hire an agent that knows it. If you make ridiculous offers landlord's won't take you seriously.
- Be prepared to sign a longer lease. In most cases (depending on the market your in and existing condition of the space) LL's won't give rent abatement on leases shorter than 3 years.
- If a space needs a lot of tenant improvements and the landlord is giving a large tenant improvement allowance don't expect much rent abatement if any.
- If a space does not need any tenant improvements and you can take a space “as is” then you have a good shot at getting rent abatement.
- Focus more on just lease rates when comparing properties. Rent abatement is only one component. When comparing your options do a side by side financial lease analysis of each property looking at the total cost of each. In your analysis look at the total dollar amount over the lease terms and the net effective rate for each. This is the best way to compare each apples to apples.
To see an example of a rent abatement provision clause in a commercial real estate lease or if you are looking for commercial space for rent in Austin Tx or if you have a website comment feel free to give us a call at 512-861-0525. Our company helps tenants find commercial space for rent and negotiate the best deal. We also help companies sublease space they don't need.