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.
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