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Net Effective Rent in Commercial Real Estate
Net effective rent is a calculation of average monthly rental cost that incorporates landlord rental concessions, typically a free month of rent. For example, if an apartment was being advertised with a net effective rent of $1500/month for a 12-month lease with one month of free rent, it might actually have a monthly rent of $1625. However, if you take the entire rent paid over the 13-month period, it actually has an average, or “net effective” rent of $1500/month.
What Net Effective Rent?
Net effective rent (NER) is a calculation of average monthly rental cost that incorporates landlord rental concessions, typically a free month of rent. For example, if an apartment was being advertised with a net effective rent of $1500/month for a 12-month lease with one month of free rent, it might actually have a monthly rent of $1625. However, if you take the entire rent paid over the 13-month period, it actually has an average, or “net effective” rent of $1500/month.
Net effective rent rate: $1,500 x 13 = $19,500
Market rental rate: $19,500/12 = $1,625/month
Net Effective Rent Can Be An Effective Marketing Tool For Multifamily Landlords/Investors
While potential tenants may feel mislead by the fact that the monthly rent is actually lower than they will pay, net effective rent can be an effective tool for landlords and property managers. And, as long as a tenant does not necessarily plan to renew their lease after their initial lease is up, it may be a good deal for the tenant as well. In general, a landlord will not offer the same rental concession for a lease renewal (particularly for a multifamily property), and, in the example above, the tenant would likely have to pay $1625 a month for each month of their second (12-month) lease.
Net Effective Rent, Tenant Improvements, and Commercial Leasing
Net effective rent can also be a major factor in larger commercial leases, such as those involving office or retail space. In addition to a month of free rent (or similar rental discounts), in this situation, net effective rent may also include tenant improvements, which must be factored in to arrive at an accurate number.
For industrial and retail leases, net effective rent may also be calculated on a per square foot (PSF) basis, for instance, $30/sq. ft.(psf)/month. For these types of leases, the present value of all future cash flows is summed, and divided by the number of periods to determine NER. In addition, since commercial leases are often longer than multifamily leases, tenant concessions may be more complex, such as six months of free rent every four years.
For example, if a tenant signed a 12-year lease on a 5,000 sq. ft. area, at $30/psf./month, they would pay the below amount over the entire period of the lease:
$30/psf/month * 5,000 sq. ft. = $150,000/month * 144 months (12 years) = $21,600,000
However, if they get 6 months free rent every 4 years, they would be receiving a discount of:
$150,000/month * 6 months * 3 (4-year periods) = $2,700,000
Now, if we take this information, we can calculate the NER per square foot for the property.
$21,600,000 - $2,700,000 = $18,900,000/5,000 sq. ft./144 months = $26.25/psf/month
Now, if we also assume there is an initial $60/psf tenant improvement allowance, we would also subtract that, like so:
$18,900,000 - $300,000 (60/psf * 5,000 sq.. ft) = $18,600,000/5,000 sq. ft./144 months = $25.88/psf/month
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Related Questions
What is net effective rent in commercial real estate?
Net effective rent (NER) is a calculation of average monthly rental cost that incorporates landlord rental concessions, typically a free month of rent. For example, if an apartment was being advertised with a net effective rent of $1500/month for a 12-month lease with one month of free rent, it might actually have a monthly rent of $1625. However, if you take the entire rent paid over the 13-month period, it actually has an average, or “net effective” rent of $1500/month.
Net effective rent rate: $1,500 x 13 = $19,500
Market rental rate: $19,500/12 = $1,625/month
How is net effective rent calculated?
Net effective rent (NER) is a calculation of average monthly rental cost that incorporates landlord rental concessions, typically a free month of rent. For example, if an apartment was being advertised with a net effective rent of $1500/month for a 12-month lease with one month of free rent, it might actually have a monthly rent of $1625. However, if you take the entire rent paid over the 13-month period, it actually has an average, or “net effective” rent of $1500/month.
The calculation for net effective rent rate is:
Net effective rent rate Market rental rate $1,500 x 13 = $19,500 $19,500/12 = $1,625/month What are the benefits of net effective rent?
Net effective rent can be an effective marketing tool for multifamily landlords/investors. It can help attract potential tenants by offering a lower monthly rent than they would otherwise pay. Additionally, if a tenant does not plan to renew their lease after the initial lease is up, it may be a good deal for them as well. Landlords typically do not offer the same rental concession for a lease renewal, so the tenant would likely have to pay the full market rate for each month of their second lease.
What are the drawbacks of net effective rent?
The main drawback of net effective rent is that potential tenants may feel mislead by the fact that the monthly rent is actually lower than they will pay. Additionally, landlords will not usually offer the same rental concession for a lease renewal, and tenants may have to pay more for each month of their second lease. Furthermore, triple net leases, which are popular in commercial real estate, come with higher monthly costs than double or single net lease structures, and tenants become responsible for taxes, which can include fines and penalties.
What are the differences between net effective rent and gross rent?
Net effective rent is a marketing tool used by landlords and property managers to entice tenants to rent their property. It is calculated by taking the gross potential rent and subtracting any rental concessions, such as one month of free rent. Gross rent, on the other hand, is the total amount of rent that a tenant pays for a property, without any rental concessions.
For example, if a tenant is offered a 12-month lease with a gross potential rent of $1800 a month, but the landlord offers one month of free rent, the net effective rent would be $1625 a month ($1800 - $175).
Effective gross income (EGI) is a calculation used to determine the profitability of a commercial property. It is calculated by taking rental income, adding other income, and subtracting the property’s vacancy. A simple EGI calculation would only involve taking rental income, adding other income, and subtracting the property’s vacancy. In contrast, a complex EGI calculation would involve more of the factors mentioned above, and would take potential market rental income and subtract loss to lease, vacancy, and credit loss, while adding any other income generated by the property.
How does net effective rent affect small business financing?
Net effective rent can have an effect on small business financing, as it can be used to calculate the present value of all future cash flows. This can be used to determine the amount of financing a small business may need to cover the cost of a commercial lease. Additionally, tenant improvements may also be factored in to the net effective rent calculation, which can also affect the amount of financing a small business may need.