Guide · Deal analysis
Face rent, effective rent, and the difference between them
Everybody quotes face rent. It is the number on the lease, the number the broker reports, and the number that goes into the market survey. It is also the number that tells you least about what a deal is worth, because it ignores every dollar you gave away to get the tenant in the door. Effective rent is what you actually end up with.
On this page
What separates the two numbers
Four things stand between the rent you quote and the money you keep.
- Free rent. Months of occupancy you granted and will never be paid for.
- Tenant improvement allowance. Cash you spend up front, usually before a single rent cheque arrives.
- Leasing commissions. Paid on the gross value of the term, typically at execution or at rent commencement.
- Other concessions. Moving allowances, a free parking period, a landlord work letter you agreed to fund.
Net effective rent, usually written NER, is what is left after all of that, expressed the same way rent is so the two are comparable: dollars per square foot per year.
The calculation, step by step
- Total the gross base rent across the entire term, including every escalation.
- Subtract the value of the free rent, at the rate that applies during the free months.
- Subtract the tenant improvement allowance in full.
- Subtract the leasing commission.
- Divide what remains by the square footage, then by the number of years.
Operating cost recoveries stay out of this. On a triple net deal the tenant reimburses those, so they are not landlord income and including them inflates the answer.
A deal worked end to end
A 5,000 square foot suite on a five year term. Base rent starts at $20.00 a square foot and escalates 3 percent a year. Five months free at the front. A $15 a square foot improvement allowance. A 5 percent leasing commission on gross rent.
| Year | Rate per sf | Annual rent |
|---|---|---|
| Year 1 | $20.00 | $100,000 |
| Year 2 | $20.60 | $103,000 |
| Year 3 | $21.22 | $106,090 |
| Year 4 | $21.85 | $109,273 |
| Year 5 | $22.51 | $112,551 |
| Total gross rent | $21.24 avg | $530,914 |
| Gross base rent over five years | $530,914 |
| Free rent, 5 months at the year one rate | ($41,667) |
| Tenant improvement allowance, $15 × 5,000 sf | ($75,000) |
| Leasing commission, 5% of gross rent | ($26,546) |
| Net to the landlord over the term | $387,701 |
Divide $387,701 by 5,000 square feet and then by five years, and the net effective rent is $15.51 a square foot. The face rent averaged $21.24. You gave away just over a quarter of the deal to get it signed, and none of that shows up in the number anybody quotes.
This is not an argument against concessions. Free rent and improvement dollars are often exactly what closes a good tenant, and a good tenant is worth paying for. The point is only that you should know what you paid, so you can tell the difference between a deal that looked generous and a deal that was.
The higher rent deal that is worse
This is where the number earns its keep. Two offers arrive on the same 5,000 square foot suite, both five years, both escalating 3 percent.
| Offer A | Offer B | |
|---|---|---|
| Starting face rent | $22.00 | $20.00 |
| Free rent | 6 months | 2 months |
| Improvement allowance | $25.00 per sf | $10.00 per sf |
| Gross rent over the term | $584,005 | $530,914 |
| Less free rent | ($55,000) | ($16,667) |
| Less improvement allowance | ($125,000) | ($50,000) |
| Less commission at 5% | ($29,200) | ($26,546) |
| Net over the term | $374,805 | $437,701 |
| Net effective rent per sf | $14.99 | $17.51 |
Offer A has the higher face rent, by two dollars a foot. It also has an average face rent of $23.36 against Offer B's $21.24, so it wins on every number that would appear in a market survey. And it is worth about $63,000 less to you over the term.
Offer A is also the riskier of the two, because more of your money goes out the door before the tenant has proven they can pay. If they fail in year two you are out $125,000 of improvements on a deal that returned very little rent.
The present value version
The method above treats every dollar as worth the same whenever it arrives. That is fine for comparing two offers of the same length, and it is how most people in the market talk about NER.
It is not quite right, though, and the direction of the error is always the same. Your improvement allowance and your commission are paid at the start. Your rent arrives over sixty months, and the biggest payments arrive last. Money you receive in year five is worth less than money you spend in month one.
A more precise calculation discounts each month's cash flow back to today at a chosen rate, then levels the result into an equivalent monthly payment. It always produces a lower effective rent than the simple method, and the gap widens the more front loaded your concessions are and the longer the term runs. For comparing a five year deal against a ten year deal, or a heavy improvement package against a light one, it is the version worth running.
Where this changes what you do
Three places, mostly.
Comparing competing offers. Never on face rent. Two proposals with the same headline number routinely differ by several dollars a foot once the concessions are in.
Deciding how to concede. When a tenant needs a lower number, giving a month of free rent is usually cheaper than an equivalent reduction in rate, because the rate reduction compounds through every escalation for the whole term while the free month is paid once. Run both before you pick.
Setting your own floor. Knowing your break even effective rent tells you when to hold and when a deal is not worth doing. It also tells you what a vacant month really costs, which is the number most owners underestimate when they are deciding whether to stand firm on rate.
The calculator that runs both versions
The Commercial Landlord's Handbook includes the working models behind this page, already built:
- A lease analysis calculator that produces both the simple and the present value effective rent
- A deal comparison tool for putting competing offers side by side
- Free rent, improvement allowance and break even occupancy calculators
- Seventeen calculators in total, plus every lease, notice and amendment for running the property