A.CRE

Net Effective Rent

The gross amount of rent payable by a tenant less any costs incurred by the landlord in order to lease the space to the tenant. Such costs typically include leasing commissions, tenant improvements and/or rent-free periods.

Net Effective Rent = Gross Rent less Landlord Costs (LC, TI, free rent)

Putting ‘Net Effective Rent’ in Context

In early 2024, Great Plains Realty Partners acquired Red River Corporate Center, a recently renovated suburban office property in Fargo, North Dakota. The 120,000-square-foot Class A building was positioned to attract professional tenants looking for modern office space at a competitive rate. As the asset manager for the property, you were tasked with analyzing leasing opportunities and optimizing the building’s cash flow. One of the key performance metrics you evaluated was Net Effective Rent (NER).

Lease Scenario:

  • Gross Rent: $30 per square foot per year
  • Leasing Commission (LC): 5% of net rent (adjusted gross rent over the lease term)
  • Tenant Improvement (TI) Allowance: $40 per square foot
  • Free Rent Period: 6 months

Step-by-Step NER Calculation:

1. Gross Rent (Over 10 Years):

120,000 SF × $30 PSF/year × 10 years = $36,000,000

2. Adjusted Gross Rent (Excluding Free Rent):

Free Rent = (120,000 SF × $30 PSF/year) × 6/12 = $1,800,000
Adjusted Gross Rent = $36,000,000 - $1,800,000 = $34,200,000

3. Leasing Commission (LC):

LC = $34,200,000 × 5% = $1,710,000

4. Tenant Improvement (TI) Costs:

120,000 SF × $40 PSF = $4,800,000

5. Free Rent Period Costs:

$1,800,000

6. Total Landlord Costs:

Total Landlord Costs = LC + TI + Free Rent
= $1,710,000 + $4,800,000 + $1,800,000 = $8,310,000

7. Net Effective Rent (NER):

NER = (Gross Rent - Total Landlord Costs) / (Square Footage × Lease Term)
NER = ($36,000,000 - $8,310,000) / (120,000 SF × 10 years)
NER = $27,690,000 / 1,200,000 SF-years
NER = $23.08 PSF/year

Insights:

After accounting for the industry-standard calculation of leasing commissions based on net rent (excluding free rent periods), the Net Effective Rent was determined to be $23.08 PSF/year. This metric provided a more accurate representation of the true income from the lease, allowing Great Plains Realty Partners to better compare this lease opportunity to others and evaluate the property’s overall performance against underwriting targets.

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