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