In today’s modern world, renting and leasing commercial real estate can be extremely complex, from credit checks to security deposits, net-zero, gross leases, and net effective rent. Unlocking the power of net effective rent in commercial real estate can help landlords and investors attract potential tenants. What is net effective rent, and how is it calculated?
Net effective rent is a strategic leasing incentive used to attract potential tenants. It represents the average monthly rental costs owed after deducting concessions. Net effective rent can be calculated by dividing the difference between the gross rent and concessions by the total lease term duration.
Using net effective rent is a great marketing tool to entice tenants, especially in times of economic distress. Let’s dive into what net effective rent is, how it’s calculated, and what the potential benefits and drawbacks may be of using it in commercial real estate.
Unlocking the Power of Net Effective Rent in Commercial Real Estate
Every commercial real estate owner aims to keep their properties filled with tenants. However, scarring from the pandemic and other economic stressors have led to many empty office and retail spaces.
Landlords and investors can use net effective rent as a strategic leasing incentive to fill these empty spaces. Here’s how to unlock the power of net effective rent in commercial real estate.
How to Calculate Net Effective Rent in Commercial Real Estate?
Net effective rent needs to be calculated anytime concessions and discounts are offered in the renter market.
Net effective rent can be calculated by dividing the difference between the total gross rent and the concessions or incentives received during a lease by the total duration of the lease term (number of months).
The net effective rent formula is:
Net Effective Rent = (Total Gross Rent – Concessions) ÷ Lease Term
If the total gross rent is unknown, multiply the gross rent (monthly rent) by the lease term.
Total Gross Rent = Monthly Rent × Lease Term
If there is more than one rental unit, use the following formula:
Net Effective Rent = Monthly Net Effective Rent × Number of Occupied Units × 12 months
Here’s an example:
Suppose an apartment is available for lease at a market rate of $1,500 monthly. However, the owner isn’t getting any interest at this price and has decided to offer one month of free rent on an annual lease.
Total Gross Rent = Monthly Rent × Lease Term
= $1,500 × 12 months
= $18,000
Net Effective Rent = (Total Gross Rent – Concessions) ÷ Lease Term
= (R18,000 – R1,500) ÷ Lease Term
= R16,500 ÷ 12
= $1,375 per month
However, the way net effective rent generally works is the lessee advertises an apartment for $1,375 net effective rent per month on a 12-month lease with the last month free. So, the tenant will be paying $1,375 per month for 13 months instead of paying $1,500 per month for 12 months. So, the gross rent remains the same.
What is Net Effective Rent?
Net effective rent is a common concept used in commercial real estate, representing the average monthly rental cost tenants pay after deducting concessions, incentives, and discounts agreed upon with the landlord and extended into a lease.
Concessions, incentives, and discounts include any benefit the landlord offers to attract more tenants to the property. Types of rent concessions include:
- Rent-free periods: A month or two of free rent is one of the most popular rent concessions. This method is frequently used in multifamily properties and is highly effective when trying to fill vacancies fast.
- Rent reduction: Rent reduction is often offered to tenants struggling financially or looking for a more cost-effective rental property.
- Allowance for property improvements: In industrial and retail properties, owners may include a tenant improvement allowance per square foot. The allowance may be used to customize the space as needed.
- Moving cost assistance: Owners may offer moving cost assistance to attract potential tenants.
- Security deposit reduction: Reducing security deposits or wavering them altogether makes a property more attractive to potential future tenants.
- Free amenity access: Free access to amenities is particularly useful for large, upper-class rental properties. Amenities can include a pool, gym, community center, and more.
Note: The net effective rent is not the actual sum owed per month – that is the gross rent. Net effective rent is the average rent a lessee pays per month of the entire lease period. The net effective rent doesn’t represent any amenities offered either.
Why Use Net Effective Rent?
Net effective rent is a strategic marketing tool landlords and investors use to attract potential tenants. It is often used in rent advertisements because of its more appealing figure that stands out in today’s overcrowded commercial marketplace.
Owners often use concessions and incentives via net effective rent to get tenants to finalize rental agreements. The total net effective rent is lower than the gross rent, and tenants often jump at the opportunity to find cheaper, better deals.
Additionally, if tenants do not plan on renewing their lease after the initial period, it can be a good deal for them, too. Landlords generally don’t offer the same concessions and discounts for lease renewals, requiring tenants to pay the full monthly market rate for the second lease.
Both investors and tenants should pay attention to the net effective rent. Investors use these figures to calculate monthly revenues and profits and to help determine property valuation, budgeting, and loans.
Conversely, net effective rent helps tenants accurately compare the rent of two or more leases. If one lease offers incentives and another doesn’t, tenants can calculate the net effective rent to accurately compare the monthly costs for each option. It also helps tenants to budget accordingly.
From a commercial real estate standpoint, net effective rent can be helpful in quickly spotting properties that are offering large concessions and discounts to potential tenants. This can indicate that they are having trouble attracting tenants to lease space, or it can indicate potential opportunities to fill the empty spaces via efficient management, which would boost the property’s net operating income.
Disadvantages to Net Effective Rent
The primary drawback of net effective rent is that tenants might feel misled when they discover their payable, monthly gross rent is more than what the net rent indicates.
Additionally, most landlords do not offer the same rental concessions, incentives, and discounts for a lease renewal; the tenants are typically required to pay higher monthly rent rates for their second lease.
Net Effective Rent vs. Gross Rent
Tenants often confuse net effective rent with gross rent. It’s important to understand the difference between the two terms.
The gross rent in commercial real estate simply refers to the total rental value a tenant is responsible for paying each month as specified in a lease contract without considering concessions, incentives, or discounts. However, the actual rental cost can differ from the stated rental costs when landlords offer incentives and promotions.
Commercial real estate leases often include concessions during move-in periods, off-seasons, and when market demands are low. The net effective rent is calculated by subtracting the concessions from the gross rent and dividing the total by the lease period.
Conclusion
Understanding how net effective rent works in commercial real estate is essential to accurately calculate the average your commercial real estate leases generate each month. Net effective rent is a powerful tool that investors and real estate owners can use to encourage potential tenants to rent their property.