Landlord Fit-Out Contributions and Rent-Free Fit-Out Periods

A rent-free period is only worth the weeks you can actually use

When a tenant leases office space, the landlord often offers two incentives: a rent-free period to build the fit-out, and a contribution towards the cost of that fit-out. Both appear in the term sheet as headline numbers, and both are usually negotiated early, by the business and its broker, before anyone has looked closely at the floor.

The misconception is that a rent-free period is a fixed amount of free time. It is not. It is a window that opens on a date the lease defines, against a floor in a condition the lease defines. If the window opens before the floor is genuinely ready, or before the landlord has approved the design, part of it is spent waiting. If the fit-out programme is longer than the window, rent starts on space nobody can yet use, and the business may also be paying for the premises it is trying to leave.

For a CFO, the value of these incentives lies less in their size than in how they are tied to handover, approvals, lock-in and exit. Those links are where most of the money is won or lost.

The incentives and what each is tied to

The lease is the only document that settles what applies to your building. The table shows the categories worth asking about.

When does the clock start?

This is the most important clause in the incentive, and the one least often negotiated.

Handover means a condition, not a date. If the rent-free period starts on a calendar date or on the landlord's notice of handover, it can start while the landlord's own works are incomplete or while services are not yet live. Ask for the start to be tied to handover of the floor in the condition the lease schedules, confirmed at a joint inspection. What "warm shell" or "bare shell" actually includes is set out in bare shell vs warm shell: what the landlord hands over, and the period should be sized against that schedule, not against the label.

Landlord approval of the design runs inside the period. Most buildings require the tenant's drawings to be reviewed before work starts. If that review is slow, the rent-free weeks are consumed without any work on the floor. Ask how long design review takes, and whether the period is extended if the landlord's review or the landlord's works run late.

Statutory approvals have their own timetable. Fire and life safety provisions sit in NBC 2016, Part 4, and building services in NBC 2016, Part 8. What a particular layout needs, and how long any approval takes, is for the project's consultants and the authority having jurisdiction to establish. It belongs in the programme that the rent-free period is negotiated against.

Size the period from the programme, not the market

Brokers often quote what is "normal" in a market. A normal period is of little use if your fit-out does not fit it.

The better sequence is to ask a designer or design-and-build contractor for an outline programme on the shortlisted floor before the term sheet is agreed. That programme should cover design and design freeze, landlord review, any statutory approvals, ordering of long-lead items, installation, testing and commissioning, and the move. Construction project management guidance such as IS 15883 (Part 1) treats planning and scheduling as a project discipline, and the same logic applies here: the date depends on the activities and their sequence, not on an expectation. Where fit-out time is usually lost, and which items govern the date, is covered in office fit-out programme: where the time actually goes.

The building's rules matter as well. If noisy work and deliveries are restricted to nights and weekends, the same work takes longer. Those rules are in the fit-out guidelines, covered in reading the landlord's fit-out guidelines before design.

Contributions, lock-in and reinstatement are one negotiation

A fit-out contribution is the landlord's investment in securing a tenant for a period. That is why it is so often linked to the lock-in, and why some leases ask for an unrecovered part to be repaid, or a rent-free period to be clawed back, if the tenant leaves early. Whether and how such a clause operates is a legal question for your lawyer; commercially, the contribution is not free money if the business may need to exit.

Three further links are worth settling at the same time:

• What the contribution may be spent on. Some landlords restrict it to permanent works such as ceilings, services and washrooms, and exclude furniture, IT and moving costs.
• Who owns what it paid for. If the landlord funded part of the fit-out, the lease may treat those items differently at exit, either as the landlord's property to be left in place or as tenant works to be removed.
• What must be reinstated. Reinstatement is a future cost created by today's design, and the incentive should be read alongside it. See lease-end reinstatement: what you owe the landlord.

The accounting and tax treatment of lease incentives, including how rent-free periods and contributions are recognised over the term, is for the CFO and the organisation's auditors and tax advisers to confirm.

Common mistakes

• Agreeing the rent-free period before the handover condition is known. The period is then fixed against work nobody has scoped.
• Letting the clock start on a date, not a condition. Weeks are lost while the landlord finishes its own works.
• Forgetting the charges that are not waived. Maintenance, utilities and parking start at handover while rent does not.
• Ignoring design review time. The landlord's approval of drawings consumes the period before work begins.
• Taking landlord's works the layout will remove. A generic ceiling and lighting grid is paid for in the deal and then demolished in the fit-out.
• Treating the contribution as separate from the lock-in. An early exit turns it into a repayment.
• Signing on the broker's "normal" period instead of a programme for this floor.

What to ask before signing the term sheet

• What exactly triggers the start of the rent-free period, and is it tied to the handover condition in the lease schedule?
• Which charges are payable during the rent-free period, and from when?
• Is the period extended if the landlord's works, design review or base-building services are late?
• How long does the landlord's design review take, and is it inside the period?
• What may the fit-out contribution be spent on, how is it paid, and against what evidence?
• Is any contribution or rent-free period repayable on exit during the lock-in?
• How are landlord-funded items treated at the end of the lease?
• Does our outline fit-out programme fit inside the period, with the building's working rules applied?

A design-and-build contractor should be able to give you that outline programme from a draft layout and the handover schedule before you negotiate, so the incentives are agreed against real dates.

Standards referenced

Fire and life safety provisions in NBC 2016, Part 4; building services provisions in NBC 2016, Part 8; construction project management guidance in IS 15883 (Part 1). Rent-free periods, fit-out contributions, lock-in and reinstatement are contractual terms specific to each lease; their legal effect must be confirmed by the tenant's lawyer, and their accounting and tax treatment by the organisation's auditors and tax advisers. Statutory approvals and services requirements for a particular floor are for the project's consultants and the authority having jurisdiction.