In this article, we’ll review rent concessions and how they affect net effective rent (NER). Then, we’ll step through how to calculate net effective rent using a net effective rent calculator or Excel. Finally, we’ll finish by answering some frequently asked questions about NER.
Even though real estate is an excellent long-term investment, no investment can escape the laws of supply and demand. There will be times when property owners will face soft market conditions. Reasons include new competition, changes in demographics or a deteriorating economy. Therefore, it’s good to know that, when necessary, you can deploy a landlord’s best friend: rent concessions. Of course, there are many types from which to choose.
Types of Rent Concessions
Rent concessions provide extra value that you, the property owner, offer lessees in return for signing a new lease. Explicitly, you can include rent concessions when you advertise your rental property, or you can negotiate them with prospects. It’s a good way to close a deal, and it’s usually less expensive than letting a space sit vacant. That’s apparent when you consider your vacancy holding costs, which include:
- Mortgage: A vacant space doesn’t contribute income that you need to make your monthly mortgage payments. The fewer units you own, the more stressful the vacancy becomes.
- Taxes: You will save on your income taxes by virtue of having less income. However, you get no such relief on your property taxes. Of course, they are the same whether the property is vacant or occupied.
- Utilities: You can’t simply shut off the heat in a vacant space during cold weather. That’s an open invitation to broken pipes. Naturally, you can temporarily turn off the hot water and electricity, which will provide minor savings.
- Insurance: This is a fixed cost that you’ll be paying whatever the occupancy status of your property. Specifically, this includes property insurance, liability insurance and possibly flood insurance.
Here are some of the most popular concessions you can use when renting out commercial real estate.
Free rent for a month or two can be a powerful inducement to sign a lease. It allows a business to use its funds to pay for moving in and any other upfront costs. Often, landlords will couple rent abatement with slightly higher rents to offset any perceived loss in net income. Alternatively, you can offer a rent abatement in the form of a lower monthly rent for the term of the lease.
Consent to Sublease
If you trust the prospect, you can offer consent to sublease. This allows the tenant to sublease the property without facing eviction for breaking the terms of the lease. You should carefully couch the terms of consent, including what types of tenants or businesses you’ll permit. You might also require the lessee to be jointly responsible for any damage the sublessee causes.
Reduced Rent Escalation
Many leases contain a rent escalation clause that specifies future rent increases at set intervals. You can offer to cap the amount of increase or cut the frequency of increases. Alternatively, you can agree to withhold escalations until the third year of the lease. Importantly, you should not cut escalations so much that they don’t keep up with the inflation rate.
Tenant Improvement Allowance
You can offer to increase a potential lessee’s tenant improvement allowance. This is money you set aside to improve or build out a space according to the tenant’s request. It might be new carpet and different paint, or perhaps new partitions and walls. Remember that you will have to finance these improvements. Therefore, include your cost of capital when you calculate which allowances you can afford to offer.
Reduced Security Deposit
You might require a smaller security deposit if the prospective tenant has a good record. For example, you might cut the deposit amount from two to one month’s rent.
Defrayed Moving Costs
Consider paying for a moving truck or making a direct payment to a moving company. Also, you can reduce the price on storage facilities the tenant might require.
Paying the Broker’s Fee
If your prospect is using a real estate broker, offer to pay the broker’s fee. A bonus is that this will help you realign the broker’s interests to coincide with your own.
One tried-and-true concession is to offer free goods or services to a prospective tenant. For example, you might offer to pay part of the tenant’s electricity bill. Also, you could offer the prospect free access to amenities that usually cost extra.
What is Net Effective Rent (NER)?
If you offer rent abatement and or cash allowances, you reduce the annual gross rent you will collect from the property. Of course, a vacant unit has the same effect. Most landlords would rather collect less rent rather than no rent at all. Something is almost always better than nothing, right? The net effective rent is the rent you collect after accounting for concessions. You can report it as an annual amount or prorate the abatement on a monthly basis.
As a side note, those investing in New York may be interested in Net Effective Rents in NYC.
How to Calculate Net Effective Rent
You can calculate NER by using our calculator (below) or an Excel spreadsheet.
Terms for Calculating Net Effective Rent
You use the following terms when calculating net effective rent:
- Base Rent: The regular monthly rent.
- Term: The length of the lease, in months.
- Free: Number of free months in the lease.
- Allowance: The tenant’s total cash allowance.
- Broker: Prorated monthly cost stemming from paying the broker fee.
Net Effective Rent Equation
The formula is:
NER = [Base Rent x (Term — Free) — Allowance –(Broker x Term)] x 12 / Term
You can easily enter this formula into Excel.
Suppose you have a vacant office space you’d like to rent out and are willing to offer concessions. You want to charge a base rent of $3,200 a month for a two-year lease on the space. To entice a prospect, you offer one month free rent and a $4,000 cash allowance. Also, you agree to pay the broker fee that will cost you an additional $256 per month. The equation becomes:
NER = [$3,200 x (24 – 1) — $4,000 — ($256 x 24)] x 12 / 24
NER = $31,728 per year or $2,644 per month.
That’s $6,672 less than your annual base rent of $38,400 (12 x $3,200), a discount of 17.4% ($6,672 / $38,400).
You can use an online calculator like the one below or do the math in Excel. Excel offers a permanent record of the calculation, but an online calculator doesn’t require programming.
Calculator Video: Effective Rent Calculation (Excel)
Frequently Asked Questions: Net Effective Rent (NER)