LEASE AGREEMENT REFERENCE GUIDE 1060: MORE FREE RENT STRATEGIES $49.95

Excerpt

MORE STRATEGIES FOR FREE RENT

The Effect of a Stronger Economy on Free Rent

It is valuable to look at what happened during the period of market softness during 1993 to appreciate the effect a glut of space can have on free rent deals. If it happened once, it will happen again. When it does, you should be ready for it.

The U. S. economy grew at an annual rate of 5.9% during the final quarter of 1993, its strongest performance in six years. And this was during a period of low inflation—only a 2.2% annual rate during the second half of 1993—according to the fixed-weight price index, the broadest measure of inflation. This robust growth sent the Dow to all-time highs during January of 1994. Could this sort of strong economy signal an end to the free rent that some landlords have been passing out to attract tenants to their properties in markets with high vacancy rates?

Maybe. But the link between the overall economy and individual tenant deals is indirect and nebulous. While robust growth is welcome news compared to the moribund economic performance of the early 1990's, local market conditions determined the extent to which free rent is a part of leases signed in 1994.

All Leasing Is Local

It was Tip O'Neill who said, "All politics is local." But he could just as well have said, "All leasing in local." The vacancy rate in individual markets—supply and demand—is the single most important factor which dictates the particular concessions a landlord will be obliged to make to attract a good quality tenant. Other critical factors include:

• the precise category of premises that the tenant seeks, whether it is office, industrial or retail;
  
• whether the tenant seeks space in a "hot" submarket, which may have lower vacancy rates than the market overall; and whether the tenant would consider leasing space in class B buildings, which have trouble competing with more modern class A space. Landlords have witnessed an exodus of tenants vacating class B space in order to upgrade to class A space for little or no extra rent.

Valuing the Whole Package

A stronger economy and the increased absorption of commercial space that it can cause at least raises this question in the landlord's mind: "Can I cut free rent out of my new deals and make it stick?"

The answer to that question often depends upon the other concessions that are part of the lease. For example, to sort out the bottom line, the following non-rent components of the deal must be quantified on a discounted cash flow per square foot basis when individual leases are compared:

• the cost of the tenant improvement allowance;
  
• any moving allowance given to the tenant to relocate;
  
• any takeover costs that the landlord will have to bear relating to the tenant's old lease for the space which it is vacating; and
  
• any pro-tenant concessions relating to occupancy cost reimbursement, such as caps on maximum contribution, exclusions of certain costs normally included by the landlord, above market expense stops for the tenant, etc.

Often, the presence of free rent in the deal depends upon the particular needs of the tenant. For example, professional firms such as attorneys, doctors, and accountants may find the idea of a substantial rent free period particularly attractive, because the cash distributions to the partners from firm revenues will be increased during the abatement period. However, whether free rent is part of the deal may just as likely depend upon the vagaries of individual markets. Free rent was rampant in 1993 in Manhattan.

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