What is rent abatement?
Rent abatements are one of many incentives included in tenancy leases.
Everyone can profit from these goodwill sweeteners, with tenants able to take a rent-free breath while landlords can enjoy the security of a long-term tenancy.
But what exactly is this provision, and what does it mean for you?
What is rent abatement?
Rent abatements are rent-free periods offered as either an upfront cost for the first year of a lease or a deduction spread equally over the lease term.
Angelo Pavanello is CBRE’s head of advisory and transaction services, including the tenant representation for both Victoria and South Australia.
He explained a good example of these two abatement forms could be enjoying one year of a five-year lease rent-free, equalling a 20% rent subtraction; or having the same percentage deducted from a monthly rent bill across the full 60 months of the rent term.
“Rent abatements basically sweeten the overall deal for tenants,” Mr Pavanello said.
How do rent abatements work?
Australian Valuers director, Craig Smith said abatement reduction rates are based on current market value, with this rate usually landing at 10-15%.
He added depending on their lease, tenants could choose to base their annual rent increases on the Consumer Price Index rather than a market percentage.
“If you feel you’re paying a lot for your lease, then you’ll probably want CPI instead of a 3-4% increase,” he said.
Rent abatements may appear to offer the same deductions regardless of their format.
However, annual rent review increases could see tenants paying above market value by the end of their lease term.
This is where due diligence is crucial, explained Mr Pavanello, who warns tenants to be wary of “creative” landlord lease structures.
“You want to make sure that if you’re going to be penalised paying above market rent, you want an above market rental abatement level to offset this,” Mr Pavanello said.
“Look at rent and abatements and other incentives in the same line.
“Both are correlated with each other so with a higher incentive … you’re going to pay a higher rent.”
Rent abatements mean different things for tenants and investors but with careful agreements and negotiations, the result will assist both sides of the story.
Benefits for tenants
For tenants setting up shop for the first time, a rent-free period is doubly important if an entirely new fit out is needed.
Mr Pavanello said such fit outs could mean a substantial cost for tenants so rent abatements were a great way to enjoy some initial breathing space.
For a tenancy already including a reusable quality fit out, tenants can save crucial capital along with rent abatements reducing rental bills, allowing for a smart financial trade up.
“You could effectively afford a higher rental level because you’re not spending a million dollars on a fit out,” Mr Pavanello said.
However, Mr Pavanello advised tenants to beware of common landlord rent abatement reasoning.
“Landlords wanting to support a higher capital value of their building in order to maintain a higher inflated capital value might offer rent abatements (where) tenants pay higher rent,” he said.
As an example of this situation, Mr Pavanello said a tenant might pay $100 a month in rent with the landlord returning $20 to them as the correct rent was only $80 a month.
Alternatively, landlords may inflate their property’s market value by pushing up rent and then giving tenants a discount.
“This brings the rate back down to what a tenant truly should be paying,” Mr Pavanello said.
“When you capitalise that inflated rate, a $1,000 property is now worth $1,300 so the landlord gets a win because the property is listed at a higher value.”
Benefits for landlords
Mr Smith said “giving a little bit away” at the start of a lease as a rent abatement was a great way for landlords to secure good tenants for the long term.
“Hopefully by doing that, you’ll be more of a secure tenant,” he said.
“You’re going to be able to afford to be there for the long term and sign the next option period rather than walking away.”
Mr Smith explained that maintaining a strong rate – which most landlords preferred to do – rather than decreasing a rate to fill a vacancy, ensured the overall market rate stayed strong as well.
A good alternative was to add more incentives to the lease.
Mr Pavanello added that strong rates added more capital value to properties with the guaranteed tenancy rental stream ensuring banks may offer higher loans to landlords if they wish to refinance.
COVID lockdowns have seen Melbourne in particular experience an increase in rent abatement requests and levels.
Mr Pavanello explained that with less demand for vacancies and less transactions, landlords had to be very willing to offer large abatements to convince tenants to commit to a new lease.
“Otherwise, these tenants will stay working on the kitchen bench and landlords won’t get any income,” he said.
Mr Smith added that government-based COVID “rent holidays” had also hurt landlords.
“Landlords are often seen as people with bottomless pockets who don’t owe any money themselves,” he said.
“But there are plenty of commercial landlords who’ve just got into the market themselves and have commitments to the bank.”
However, tenants in need of rental relief in difficult times have welcomed the move from state governments with the financial aid helping many to stay afloat in tricky times.