Net effective rent is derived from the rent that a lessee pays on average per month of a lease period. It is not the actual rent that he/she pays every month.
Net effective rent is calculated by taking into consideration all the additional rents or concessions that are provided over the lease period. The renter’s net effective rate is the total gross rent for the entire lease period divided by every month in the period, including any free months.
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Calculation of net effective rent
Net effective rent is calculated by using the total rent payable throughout the lease period and dividing it by the whole period.
For example, Adam signs a lease agreement and agrees to pay $3,000 per month over a 12- month lease period. However, to attract Adam to lease the apartment, the landlord provides a two-month rent-free concession for him.
The effective rent payable for Adam would be calculated by taking the sum of the rent expenses divided by the whole lease period. ($3,000 x 10) / 12 = $2,500
Adam’s net effective rent is $2,500 per month as he enjoys a savings of $500 or 16.67% discount on his rent.
Difference between net effective rent and gross rent
The gross rent is the flat monthly amount that you will pay during a lease period. This can include all the associated costs of renting the apartment, such as utilities, building dues, and maintenance fees, but this is not always the case. Gross rent will always be higher than net effective rent and vice versa. Given the unpredictable nature of the operating expenses for a building, most landlords are reluctant to lease space on a gross basis.
On the other hand, net effective rent will be slightly more complicated as it takes into account all concessions and noises that would affect the rent received by the landlord. Simply put, effective rent is the average amount of money that will come out of your pocket each year or month when averaged out over a period of time, typically your lease term.
Why is net effective rent important?
Net effective rent is important when it comes to comparing lease alternatives. It provides a fair comparison amongst leases by eliminating concessions and noises. It helps a tenant to be aware of the landlord’s negotiation tricks.
For example, the first few periods of the lease may be cheap and affordable, to lure tenants into signing the agreement. However, the landlord might include a rent step-up clause that will increase the rent over each period. Ultimately, the tenants might end up paying more than the market rate.
The other issue with net effective rents is that the concessions that create them usually last only for your first lease. If you renew your lease without another concession, you will be paying the higher monthly rate for good, and your total annual spending on rent will increase.
Net effective rent is a crucial determinant for investors as it affects their effective income and IRR. Returns are calculated based on net income, which is net effective rent collected from the tenant.
When evaluating lease options, it is important to look at the net effective rent payable instead of gross rent. Ultimately, net effective rent is the amount that you will be paying/receiving without concessions, which shows the true value of the lease. It is also important to look out for rent review clauses such as step-up rent that would significantly affect your net effective rent payable.
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Disclaimer: The information and/or documents contained in this article does not constitute financial advice and is meant for educational purposes. Please consult your financial advisor, accountant, and/or attorney before proceeding with any financial/real estate investments.