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.