Concessions
Also referred to as an “Inducement”, any preferential financial treatment offered by one party to another in a real estate transaction. In the case of a lease agreement, a concession most often takes the form of free rent for a period of time or an agreement by the landlord to waive certain charges such as parking charges or pet fees. These concessions are meant to induce the tenant to sign the lease. Concessions are most often used during initial lease-up (i.e. when a building first delivers) or during tenant-friendly periods in the market cycle to maintain rent rates.
Putting ‘Concessions’ in Context
Scenario:
Suncrest Development Group has recently completed the construction of a luxury apartment complex, Bayshore Luxury Residences, located in the highly desirable Bayshore Boulevard area of Tampa, FL. The development features 200 high-end units with amenities such as a rooftop pool, state-of-the-art fitness center, and premium finishes throughout the apartments. Given the competitive nature of the Tampa rental market, and the need to achieve a certain level of occupancy quickly, Suncrest Development Group decides to offer rental concessions to attract tenants during the lease-up phase.
Concessions Offered:
To incentivize prospective tenants to sign leases quickly and to help stabilize the property’s cash flow during the initial lease-up period, Suncrest Development Group offers a concession of one month’s free rent for all new leases signed within the first three months of the property’s opening. For example, if a tenant leases a 2-bedroom unit for $3,000 per month, they would only pay $33,000 for the first year instead of $36,000.
Calculation Example:
Let’s consider the financial impact of this concession on the property’s revenue during the first year. If 50 units are leased within the first three months, each with an average monthly rent of $3,000, the total gross potential rent without concessions would be:
50 units × $3,000 × 12 months = $1,800,000
However, with the one-month free rent concession, the effective gross income for these units would be:
50 units × $3,000 × 11 months = $1,650,000
Impact and Considerations:
The concession results in a $150,000 reduction in gross potential rent for the first year across those 50 units. While this reduces the initial cash flow, the developer anticipates that the concession will accelerate lease-up, leading to quicker stabilization and ultimately stronger long-term performance. Additionally, by offering the one-month free rent upfront, the developer maintains the integrity of the market rent rate, avoiding the need to lower the advertised rent, which could have long-term negative effects on the property’s perceived value.
In this hypothetical scenario, the use of concessions is a strategic tool to manage lease-up risk and ensure that Bayshore Luxury Residences achieves its targeted occupancy level within the desired timeframe. This approach is particularly common in opportunistic developments where the emphasis is on stabilizing the property quickly to either sell at a profit or refinance under more favorable conditions.
Frequently Asked Questions about Concessions in Real Estate Leasing
What is a concession in real estate leasing?
A concession, also referred to as an “Inducement,” is any preferential financial treatment offered by one party to another in a real estate transaction. In a lease agreement, it often takes the form of free rent or waived charges such as parking or pet fees.
Why do landlords offer concessions?
Concessions are used to induce tenants to sign leases. They are commonly offered during initial lease-up periods or during tenant-friendly market cycles to maintain rent rates while attracting tenants.
What are common types of lease concessions?
Common types include free rent for a period of time and the waiving of specific charges, such as parking fees or pet fees.
When are concessions most commonly used?
Concessions are most often used during the initial lease-up of a property or during tenant-favorable periods in the market cycle.
How did Suncrest Development use concessions for Bayshore Luxury Residences?
Suncrest Development Group offered one month’s free rent on all new leases signed within the first three months after opening to quickly attract tenants and stabilize cash flow.
What was the financial impact of the concession in the Bayshore example?
The concession reduced gross potential rent by $150,000 for the first year across 50 leased units. Instead of earning $1,800,000, the effective income was $1,650,000 due to the one month of free rent per unit.
Why not just lower the monthly rent instead of offering a concession?
Offering a concession allows the landlord to maintain the integrity of the market rent rate, avoiding long-term damage to the property’s perceived value that could result from lowering advertised rents.
What is the strategic goal behind using concessions in lease-up?
The goal is to accelerate lease-up, achieve occupancy targets quickly, stabilize the property’s financial performance, and prepare for future opportunities like selling or refinancing.
Click here to get this CRE Glossary in an eBook (PDF) format.