Net effective rent is the amount a lessee pays on average for each month in their lease period. However, it isn't the actual monthly payment. Instead, it also accounts for the concessions offered by a commercial property owner (such as a free month's rent) to win that tenant away from a competitor's property in a market with a high vacancy rate.
What is net effective rent?
Net effective rent, often shortened to effective rent, is the average monthly rent on a property after accounting for incentives or concessions by the landlord. This calculation divides the total rent over the entire lease term by the number of months covered by the lease. Because of that, the net effective rental rate is often lower than the gross rent or actual amount paid by a lessee each month.
What are the factors impacting net effective rent?
When the owner of commercial real estate markets their available rental space, the list price for the property, also known as asking rent, is the rate they will charge a renter each month. However, a lessor will sometimes offer concessions that reduce the effective rent paid by the tenant as an incentive to lease their space in a competitive market. These can include:
- Free rent periods: In a market with lots of vacancies, a landlord might offer a free first month's rent to entice a tenant to sign an apartment lease. Lessors can also provide a rent abatement period, which allows a new commercial tenant to complete the build-out of space to meet their needs.
- Tenant improvement allowance: A property owner can invest money to make improvements on behalf of a new tenant to meet their needs. They can also offer an allowance that reimburses improvement costs as well as move-in expenses.
- Real estate broker commissions: Landlords usually pay the commission for real estate brokers who help secure a tenant for their space. However, if the lessee didn't work with a broker, the landlord could reduce their gross monthly rent or provide them with a period of free rent.
How to calculate net effective rent
Net effective rent is a simple calculation. A lessee/lessor divides the total gross rent to be collected by the number of months in a lease term.
For example, an apartment owner markets a vacant unit in their building by asking $1,000 a month in rent. However, to incentivize a tenant to sign a two-year term, they're offering free rent for the first month. As such, the tenant would pay $1,000 a month for 23 of the 24 months, for a total of $23,000 in gross rent during the lease term. That yields a net effective rental rate of $958.33 a month.
Similarly, the owner of 1,000 square feet of vacant office space is asking for $35 a square foot (sf) per month in rent or $35,000 in total gross monthly rent. However, to incentivize a tenant to sign a long-term net lease for 10 years, the landlord is offering the following lease concessions due to the competitive market conditions:
- A lump-sum tenant improvement allowance of $100,000 to renovate the space and cover some moving expenses.
- Six months of free rent during the renovation and tenant move-in period.
Given these concessions, a tenant would pay the $35/sf rate for 114 months while also benefiting from the $100,000 allowance for improvements and move-in expenses. As such, the total gross rent paid during the lease term would be $3.9 million, or $33,241.67 a month, giving it a net effective rental rate of $33.24 per sf.
Net effective rent versus gross rent
Landlords will often advertise both asking rent and effective rent to help prospective tenants compare offers on different real estate leases in highly competitive markets. This gives the lessee a better idea of the total cost of a lease during the entire term.
One thing that prospective renters need to keep in mind is that the net effective rental rate isn't what they'll pay each month. Their payment each month will be at the asking rate, except during any free rental periods.
Net effective rent helps renters compare lease offers
Net effective rent is a useful calculation for renters because it allows them to compare the total cost of commercial leases. It can show that a property with a higher asking rental rate might be the cheaper option given the landlord concessions. Further, in competitive markets with high vacancy rates, renters can also use it as a negotiating tool to potentially win higher concessions from a landlord during a lease term.