Leasing Incentives That Don't Detract From Valuation

The Real Estate Espresso Podcast

Leasing Incentives That Don’t Detract From Valuation

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Introduction to Leasing Incentives That Don’t Detract From Valuation

Today, I will share some valuable insights into the world of real estate investing. All real estate investors understand the importance of maintaining the value of their properties. In order to attract tenants and prevail in the competitive real estate market, one might consider offering leasing incentives. However, the ultimate question remains: how can these incentives be structured so as not to detract from the building’s overall valuation? Let’s delve into the subject.

The Catch-22 of Leasing Incentives

The mainstay method for building valuations is income-based, meaning that not every incentive offered to potential tenants will conserve the building’s value. This is because the net operating income, obtained by subtracting operating expenses from the gross rent, is divided by the market capitalization rate to reach the building’s value. Naturally, increasing expenses or reducing the gross rent impacts this calculation, ultimately resulting in a decrease in the building’s overall value. Navigating this catch-22 requires careful planning.

Preserving Building Value with Capital Investments

One possible solution to the incentives conundrum involves categories of building expenses. Expenses associated with capital improvements, such as materials like paint, bricks, and gypsum board, get associated with the building’s balance sheet. So, certain leasing incentives like a large-format TV or Amazon gift cards can be capitalized as they are viewed as initial invested capital in the property. This smart finance strategy helps maintain positive balance sheet items while still providing attractive incentives for potential tenants.

Possible Leasing Incentives	Impact on Building Valuation
Discount on Rent	Detracts from valuation due to lower gross rent
Free parking or free months of rent	Can be neutral to valuation as the total rent can be shown as paid full, and the free parking doesn’t impact the charged amount
Capital Improvements (TVs, Window Treatments, Ceiling Fans)	Neutral or positive impact on valuation, as these are treated as capital expenses not operational ones

Knowing how to navigate these financial minefields is essential for sustaining and even enhancing the value of your properties. However, it is important to always seek advice from a certified public accountant to ensure your incentives comply with Generally Accepted Accounting Principles (GAAP). With the right knowledge and advice, armed with creativity, you can provide your tenants with enticing incentives that don’t negatively impact your income statement or dilute your property’s value.

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