Effective Rent is defined as the remaining cash the landlord receives after paying all expenses for operating the property, and any costs for tenant work to get the space ready for occupancy. Effective rent is also often referred to as Net Effective Rent (NER).
Effective rent is expressed in amount per area unit per time unit i.e. USD/SqM/mo. and is calculated over the lease duration. It is a common practice to take time value of money into account while calculating the effective rent.
Base rent (quoted rent), tenant improvements (TI), rent-free period and escalation clause are the main variables. A lease with 2% annual escalation clause is likely to have a lower effective rate than a lease with annual escalation tied to the consumer price index (CPI), because historically CPI has been more than 2% per year. Studley publishes analysis of major real estate market and Effective Rent Index.
Example of Effective Rent Calculation
Suppose a landlord has a commercial space of 1,000 SqM with a base rent of 260 USD/SqM/year. Tenant incentives include six months of free rent and $40/SqM in extra tenant improvement. The landlord's discount rate is 10% and the lease term is 5 years.
Find the present value of the total rent over lease duration = 985,605
Present value of rent free period = 118,182
Present value of Tenant Improvement = 40,000
Total present value of effective rent = 827,423
Total present value of effective rent/SqM = 827.4
Convert this present value to annuity, use the formula =PMT(Discount Rate, Lease Duration, PV) = 218.27
Hence, Annual Effective Rent = $218.27 per SqM
Effective rent is a very useful parameter while comparing various lease offers having different lease duration.
Hope you enjoyed this post on effective rent. What do you think about this calculation, use the comment section below. You can also download the unprotected Excel workbook containing the effective rent calculation example.
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Naiyer, Thank you for this article. I have a question. If you have a building where a lease has just been signed and you wanted to determine the “market rent” in order to determine the “Fee Simple as if at market” value of the building would you use the effective rent or the contract rent or something in between?
Welcome Ethan! To find the value of a building you must use contract rent less operating expenses. Net effective rent is used to compare various lease deals. If you have four lease offer for a space with different terms, you should use net effective rent to compare them.
Thank you very much for sharing! I have a few questions about the effective rent calculation:
1) Is there any difference between effective rent & net effective rent, or they are referring to the same calculation?
2) Is effective rent meant to calculate by lease? That means if I am to determine a building’s effective rent which contains multiple leases, I still have to calculate the effective rent by lease and do some kind of averaging to get the effective rent/RSF?
3) Do I need to factor in leases with operating expense subjected to base?
You made some decent points there. I checked on the web to find out more about the issue and
found most individuals will go along with your views on this web site.
We have three warehouse leases which are expiring on 31 May-2015. The landlord have given us a proposal to reduce the rental per sq. ft. How do I evaluate an analysis whether the new proposed rental rates of SGD5.2 per sq. ft. is acceptable?
This is really great! Is there a way to expand this to a 10 year lease? I put in the term line that we will have a 10 year lease, but the calculation does’t expand to 10 years, it stays at 5. Is there a way to do this?
So effective rent is the same as market rent or not? If I want to valuation a freehold of a property, can I use the effective rent in review ? What if it?s a FRI lease do I need to deduct outgoings from effective rent?