Be Careful When Offering Lease Incentives in a Post COVID-19 Down Market

Posted by  wasserman 

The law is very clear on this subject and has recently been circulated by the Rent Board in light of the COVID-19 crisis: A landlord who grants a rent reduction due to market conditions makes that reduction permanent. This means that future rent increases must be based off of the lowered amount, which becomes the new base rent. In addition, the property owner is likely precluded from withdrawing or canceling the reduction at a later time.

A rent reduction may only be rescinded or canceled if the tenant has requested a temporary adjustment based upon an economic hardship specific to that tenant’s personal or household situation. For example, the tenant is laid off or is ill (i.e., due to COVID-19), or encounters unexpected expenses to care for a member of the tenant’s home. In those instances, the landlord and tenant should clearly document the hardship and should spell out, in a signed writing, the amount of the reduction, why the reduction is being granted, and the length of time for the reduction.  The SFAA COVID-19 Forbearance Agreements may be tailored to accomplish this objective.

Rebates and incentives are also very dangerous when given to dissuade tenants from leaving in a declining market or to entice new tenants to sign up at an unattractive rent. About 20 years ago, a large apartment operator in San Francisco offered incoming tenants “rent coupons” for use each month to lessen their rental obligations. For instance, Tenant A’s lease states that rent is $1,200 per month, although similar apartments were not renting at that level. To induce Tenant A to sign the lease at this amount, the landlord offered $1,200 worth of coupons for the first year of the tenancy. Consequently, Tenant A could submit a $100 coupon with each monthly rental payment, thereby only paying $1,100 out-of-pocket during Year 1. This landlord subsequently discontinued the coupon program when the rental market improved. Hundreds of affected tenants then pursued massive litigation in protest. The Rent Board held that, using this example of Tenant A, initial base rent was legally $1,100 per month for every year of the tenancy because the discount afforded by the coupon incentive was to be permanently built into the rental obligation and could not be legally withdrawn.

Other property owners have been held liable when they offer a free month of rent or engage in other gimmicks to effectively lower the tenant’s initial rent obligation, only to later take away the incentive once market conditions pick up. Indeed, if you offer a month’s free rent for a one-year term, the Rent Board will say that the value of that month is then amortized over the 12-month period of the initial term and then lowers the base rent for all future months by that amount. As one judge put it, you cannot evade rent control by setting up a lease with a starting rent higher than what the current market would justify in order to entice tenants to sign the lease.  Other incentives like handing out a substantial gift certificate may also draw a similar ire. 

The Rent Board policy is therefore quite clear. Rent rebates or reductions may only be lawfully rescinded, canceled, or withdrawn if the rebate or reduction is given because of a tenant’s particular need or hardship. A soft rental market is never a justification for a temporary reduction in rent. So if you do grant a reduction or offer an incentive in order to attract new tenants or to keep an existing tenant from moving due to a change in the marketplace, you risk making that reduction or the value of the incentive a permanent component of base rent.