INCENTIVES – ANZ NOTE
purpose of this guidance note is to provide information, guidance and
advice on leasing incentives to Members undertaking tasks involving
the assessment or analysis of rental and capital values.
Status of Guidance Notes
notes are intended to embody recognised ‘good practice’ and
therefore may (although this should not be assumed) provide some
professional support if properly applied. While they are not
mandatory, it is likely that they will serve as a comparative measure
of the level
performance of a Member. They are an integral part of ‘Professional
Scope of this Guidance Note
guidance note applies to Members assessing the impact of leasing
incentives on rental and capital values particularly in relation to
International Valuation Standards
guidance note recognises the International Valuation Standards 1 and
2, and the International Valuation Application 2, effective from 2005
by the International Valuation Standards Committee and it is intended
to be consistent with the concepts and definitions contained in those
standards, however, there may be departures from IVSC Standards to
reflect Australian & New Zealand law and practice.
the 1960’s the commercial property market has experienced increased
volatility. This is primarily because demand lead time is far shorter
than the time needed to create more supply. This cyclical pattern is
unlikely to change in the foreseeable future so that valuation
methodology and techniques and the practitioners themselves must be
to cope with the varying market conditions – no matter how extreme.
Over Supply Leading to Incentives - Analysis of Evidence Essential
of office space in most of the major cities has led to incentives
being offered to prospective and existing tenants. Whilst these
incentives are of prime importance to the parties directly concerned,
they are also important to the market place as a whole to the extent
that they may affect market rental values. The analysis of rental
for comparative purposes is an essential part of the valuation
process and is of particular relevance where rent reviews and asset
valuations are under consideration.
Range of Opinions
range of opinions amongst valuers and their clients as to how leasing
incentives should be interpreted has resulted in a broad ranging
Intention of Clarifying Principles
response to specific requests, this guidance note has been prepared
with the intention of clarifying the principles involved.
No Uniformity of Market Conditions
review of the situation in the various cities clearly shows that
there is little uniformity in market conditions.
tends to be the normal situation and makes it impractical to
enunciate Practice Standards on how matters must be evaluated.
Skill of the Valuer is to Investigate
traditional skill of the valuer is to investigate, report and
evaluate the specific situation being considered, taking into account
the differing factors which affect rental levels and capital values
in the particular location or market.
Many Factors to Consider
factors include the wording of the pertinent lease clause (of which
there are countless variations), the state of the building, the
general market, the size and duration of the lease, case law, and
many other factors of which incentives granted on new leases are but
Rent Freely Negotiated Between Two Parties The consideration paid for
the right to occupy premises owned by another usually takes the form
of a periodic rent which, in the case of new lettings, is negotiated
freely between the two parties. Rental value is assessed by various
methods. In the case of office space, the method most frequently used
in rental review determinations is to analyse rents paid for
comparable space, thereby deriving a rental rate to be applied to the
values normally refer to accommodation that has been completed up to
the stage of the tenant’s fit out.
Supply and Demand - excess of supply
fundamental laws of economics apply and in the case of the office
market, it is difficult, given the lead time involved in supplying
new space to the market, for supply to respond quickly to rise or
fall in demand. Surplus space can be withdrawn from the market place
but owners are understandably reluctant to take this course.
a significant excess of supply over demand is demonstrated, rental
values may fall.
Incentives for Leasing New Building
periods of oversupply of accommodation, incentives are often granted
during the leasing up of a new building and these amounts are
regarded by the owner/developer as part of the capital costs.
Incentive to Move
cost of fitting out and relocating can be high and without an
incentive from the landlord which meets all or at least a substantial
part of these capital costs tenants would, in many instances, not
move to new premises.
Sustaining Rental Levels in Times of Over Supply
rentals are to be sustained in times of oversupply, some form of
compensatory consideration may be required to achieve new lettings.
That consideration, where it occurs, is also part of the incentive in
whatever form it may take.
Incentive Benefit Offset Against Commitment
consideration of incentive, may take the form of a capital payment or
relief from a revenue obligation. In either case the tenant receives
a benefit which will be offset against the totality of the tenant’s
rental commitment and fit out cost.
Incentives Even in Balanced Market
is relevant to note that lessors have often given incentives to
in-going tenants, even when the leasing market has been balanced in
terms of supply and demand.
Extent Incentive is a Reduction of Rent
has to be assessed is the extent to which a particular incentive
package includes an amount, which might be regarded as a reduction
from the stated rent. It is noted that leasing incentives have
sometimes increased in anticipation of increasing vacancy factors and
to create a false rental base, which may cause difficulty in the
analysis and assessment of rentals and capital values.
Valuer to Decide Appropriate Technique
are several techniques for arriving at a value, which are well known
to practising valuers some of which are appropriate to different
situations. It is up to the judgment of the Valuer in each case to
decide which of the techniques to use. In many cases the Valuer may
utilise more than one technique in the process of producing a
Effective Rental Value
Converting Incentive Into Periodic Equivalent
it is determined that an incentive has been paid, the valuer is
called to utilise judgment in the light of the current conditions in
the location concerned as to whether any element of the incentive
should be regarded as a de facto rent reduction. This element should
be converted into a periodic equivalent over the term of the lease.
equivalent should be deducted from the nominated or passing rent in
order to arrive at the effective rent.
effective rental should represent the most valid interpretation
the transaction concerned for comparative purposes, which may not
necessarily represent market rent.
Interpretation of an Incentive in Terms of Cash Flow
should be taken to ensure the correct interpretation of an incentive
in terms of cash flow. For example, a lump sum payment equal to three
years rental, paid at the start of the lease, will not equate to an
actual rent-free period of three years.
Points to Consider in Rent Reviews
reaching a view as to the rent that should be adopted on review the
valuer may take many points into consideration including:
specific wording of the subject lease clause;
relevant case law;
rents being agreed between landlord and tenants on review for similar
tenancies in the area;
size of the tenancy concerned relative to the size of space of
available comparable rentals;
fact that a review to market rent may not necessarily be influenced
by the level of rent previously passing unless required under the
rents on review may
fall as well as rise according to prevailing market conditions unless
there is provision in the lease to prevent the rental falling;
guidance should be
sought from a wide range of rentals including rentals freely
negotiated at review dates and rentals for new lettings both of which
may or may not truly reflect the rent which would be paid
the market. The circumstances of the rentals must be fully
investigated and appropriate adjustments may be required up or down
in the valuation process;
possibility of incentives having an effect on the stated rent as
outlined in points 3.1 and 3.2 where new lettings are considered in
reaching a view on the current market rent;
valuer should have regard to this practice and decide as to whether
the amount of the inducement is greater than a reasonable inducement
to move and assess as to whether, in all the circumstances, all or
of the incentive granted would be regarded as a rental rebate.
Deciding the Weighting to Apply to Evidence
time to time a valuer will be faced with rent reviews occurring, some
of which have had regard to the level of effective rent created by
incentive payment while others in the same building (or similar
buildings) demonstrate a disregard for such consideration.
the Valuer should examine the particular premises, the remainder of
the term available and the particular conditions of the lease before
deciding the weighting he needs to apply to such evidence in the
process of assessing market rent. In fact the lease conditions may
require an assessment of a rent level that is not market rent.
Encouragement for Full Disclosure
clauses and side agreements in leasing arrangements are a negative
development and every encouragement should be given to lessors and
lessees to provide full disclosure of all lease arrangements.
arrangements are clearly against the operation of an informed market
and are thus undesirable.
Serious Repercussions Can Flow
Institute recognises that two parties have the right to
confidentiality of their commercial arrangements. However, the
Institute believes that serious repercussions can flow from the use
of non-disclosure or secrecy clauses particularly when their use may
distort valuations based on inadequate information.
accepting instructions valuers should where possible:
enquire in writing as
to the existence of any secrecy clauses or side agreements;
obtain a written
Refuse to Act
valuer has a right to refuse to act in instances where it is
considered that the lack of information prejudices the valuer’s
ability to discharge the responsibility of making the assessment.
discharging this responsibility the valuer should be aware of the
liability for potential claims for professional negligence or
capital value of an income producing property should be arrived at by
capitalising the market rent making adjustments for any continuing
rent free periods, vacancies, leasing up costs, reversions,
outstanding repairs/renovations, the strength of lessees’
covenants, lease terms and so forth.
a stable market, the assessment of market rental value and the
appropriate capitalisation rate can be undertaken without undue
difficulty, notwithstanding the degree of research required. The
introduction of incentives coupled with a relatively inactive market
makes the valuation process more complicated and, possibly more
Matters for Consideration
is recommended that careful consideration should be given to the
following matters in addition to the matters referred to above:
relativity between the passing rent and market rental value indicated
by the long-term rental trend line in the relevant market;
need to distinguish between passing rents, market rents and effective
rents and their relative growth patterns and the relationship with
real net cash flow;
proper assessment of the sustainable level of net income;
allowance for the reversionary value of lower than market level
capitalisation rate to be applied in the light of market rental
levels and the position of the property market in its cyclical
danger of applying a capitalisation rate to a passing rent which, for
whatever reason, does not represent market rent;
precise interpretation of the rent review clause(s);
where appropriate, a
comparison between the Internal Rate of Return derived from the cash
flow as analysed in the above process and the Internal Rate of Return
required by buyers in the market place at the date of valuation;
for letting up and leasing incentives for vacant areas;
for any building works or refurbishments needed;
possible tax implications.
do not set the market, they interpret it.
Interpreting Varying Conditions
market and market practices are subject to continuous change.
Consequently, the valuer should interpret these varying market
conditions in the application of established methodology.
Market Dictates Value
Courts have often noted that it is the market that dictates value
(Broken Hill Pty Co Ltd v Australian Mutual Provident Society,
reference The Valuer,Vol. 29 at 340).