Lease incentives for landlords

What counts as a lease incentive?

Any payment or benefit the landlord gives the tenant that is linked to entering into the lease: rent-free or reduced-rent periods, cash paid to the tenant, contributions towards the tenant's fit-out, paying the tenant's relocation or legal costs, and taking over the tenant's obligations under its old lease elsewhere. The test is substance: if the tenant would not have received it without signing the lease, it is an incentive.

Lease incentives: a worked example

A landlord lets offices for 5 years at a headline rent of CU 1,000 thousand a year. The tenant pays no rent for the first six months, and the landlord pays it 300 thousand towards its own fit-out on signing. Lease payments net of incentives are 5,000 - 500 - 300 = 4,200 thousand, so rental income is 840 thousand a year.

Year 1 income is 900 - 60 = 840 thousand, and so is every later year. The rent-free period builds up accrued income and the cash incentive sits as an asset; both are recovered as the tenant pays full rent in later years. See straight-line rental income.

Is a fit-out contribution always an incentive?

No. If the landlord pays for works that become part of its building and would benefit any tenant, such as upgrading lifts, air conditioning or the base-build finish, they are improvements to the investment property and are capitalised. If the money pays for the tenant's own fit-out, such as its partitions, furniture and branding, which the tenant controls and may remove, it is an incentive. Contributions that the tenant spends as it chooses, with no control by the landlord over what is built, are treated as incentives.

How are letting fees and legal costs treated?

Initial direct costs, the incremental costs of obtaining the lease such as letting agents' fees and legal fees, are added to the carrying amount of the property and expensed over the lease term on the same basis as the lease income. A letting fee of 60 thousand on this lease would be charged at 12 thousand a year under the cost model. Under the fair value model the cost is added to the property and then absorbed in the next revaluation. Internal leasing staff costs are not incremental and are expensed.

How do incentives interact with the valuation?

As with accrued rent, the valuer's figure already reflects the lease as signed, including the incentives given. The lease incentive asset and the accrued income are recognised separately, so the investment property is carried at the valuation less those balances, to avoid counting the same future rent twice. See property valuations under IFRS 13.

What does the tenant record?

The tenant applies lessee accounting. Incentives received at or before the start of the lease reduce the right-of-use asset, and incentives still to be received reduce the lease payments used to measure the lease liability. The rent-free period is reflected automatically because no payments are due for it. See IFRS 16 lessee accounting.

What about incentives on a renewal or extension?

A renewal agreed during the lease is a modification: it is accounted for as a new lease from the date of the change, and any incentives given for it, together with balances left from the original lease, are spread over the new lease term. Incentives given to keep a tenant who could otherwise leave are therefore spread, not expensed.

How does US GAAP compare?

ASC 842 also deducts lease incentives from the lease payments, so a landlord spreads them over the lease term and a tenant reduces its right-of-use asset. Initial direct costs have the same definition, costs that would not have been incurred had the lease not been obtained, so allocated overheads and the costs of negotiating leases that are never signed are expensed under both. See IFRS 16 lessor accounting and real estate accounting.

This guide is general information. It is not tax or legal advice for your situation.