Empty spaces – alternatives to reducing rents to fill retail rental spaces

By Andy Yap

Special to Ontario Construction News

In boom and bust real estate markets alike, landlords are constantly challenged by changing trends. Vacancies in retail space are commonplace, even in the most sought-after neighbourhoods. If you take a walk around your area, it is likely you will notice properties that have been vacant for months.

It begs the question, why do spaces remain empty in prime locations around our cities?

There can be a multitude of factors. A common observation is that traditional bricks and mortar retailers are impacted by the rise of the digital economy and the changing consumer purchasing habits. More people shopping online can translate to fewer people visiting the stores.

On the other hand, the changing workspace environment such as office hoteling, hot-desking, and allowing employees to work remotely have contributed to different demands from office tenants, which landlords have to accommodate in order to satisfy tenant retention.

To fill or not to fill

Perhaps one of the lesser known reasons is that landlords of retail spaces are not incentivized to fill vacancies with tenants who are unable or unwilling to pay market rent. For the passerby who sees the same For Rent signs in their community month after month, this seems counterintuitive. There is an assumption that having a tenant paying something is better than nothing. But signing a multi-year lease at below market rent is problematic, particularly for smaller landlords, because the lower revenue stream may negatively impact their value. Recent trends have seen some landlords leasing the space temporarily to “pop-up” stores to fund the operating costs, rather than committing to a medium-to-long term low-value lease.

Tenant inducements

There are several things that landlords can do to fill empty spaces and get the rent they want. Below is a list of inducements that you may be offered to potential tenants in order to entice them to rent properties.

• Cash inducements – attracting new tenants with a one-time cash payment at the time of signing.
• Tenant improvements and fixture allowances – offering to finance improvements to the premises to refit the property to serve the tenant’s needs. This can be facilitated in several ways, including hiring contractors to do the work or permitting the tenant to find their own. The landlord may choose to allow the tenant to draw from an agreed-upon pool of money or they can submit a bill for the work done. Improvements may also be used to persuade tenants whose lease is coming due to stay. By offering to fund updates and upgrades, the landlord increases the likelihood of keeping a long-term tenant
• Rent-free period – providing a period of time where the tenant does not have to pay rent. Known as a rent-free period, in reality the landlord is averaging down the cost of the monthly rent over the period of the lease, thereby alleviating any issues around the devaluation of the property.

What is the motivation?

Before deciding to use these inducements, a landlord will want to consider what the motivation is, aside from attracting a tenant, because there are both accounting and tax implications for each, and in some cases they do not align.

As a landlord, there are two competing motivations. One focused on the tax implications and the other is viewed from an accounting lens.

• Tax viewpoint – finding the most tax-efficient way to report inducements to provide a favourable tax result.
• Accounting viewpoint – having strong financials shows potential investors and lenders that, from an accounting perspective, the inducements are not impacting the bottom line.

When a landlord applies for a loan or wishes to sell a property, financial metrics are important. The motivation is to allow for the accounting treatment of the inducements to have a positive impact to show prospective lenders and buyers.

Below is a chart that shows the general treatment that each of the inducements has, from both tax and accounting perspectives, for the landlord. This assumes that leasing is part of the landlord’s ordinary course of business. This is by no means an exhaustive list but instead provides a source of reference.

Andy Yap is a partner, tax at Fuller Landau LLP, phone (416) 645-6536, email ayap@fullerllp.com.