What is the landlord’s Net Effective Rate for a lease transaction and why should a tenant care?
For every lease that a landlord negotiates with a tenant, there is a “net effective rate” (NER) for the lease. At any given time, based upon the current rental market, most landlords and their representatives have a minimum NER they want to achieve. If the deal being negotiated exceeds that NER, then the deal may not need to “go up the ownership chain” or out to the lender for approval. If, however, the proposed lease does not meet the landlord’s minimum NER threshold, the lease being negotiated will likely need further approvals, beyond the landlord’s leasing agent. So, how is the NER calculated?
Essentially, the NER is based upon the present value of the rents (and parking income, if applicable) over the lease at some chosen discount rate, reduced by the PV constant (payment, if amortized over the term of the lease) of the landlord’s concessions and other costs, such as the tenant improvement allowance, rental abatement, forgiven or reduced rental, and leasing commissions. To address this further, consider the following example.
You have a lease proposal which is for 66 months, net (plus operating expenses), with 6 months of net rent abatement (rent only), a rent starting at $25.00/RSF and increasing by $0.50/RSF on each anniversary of the rent commencement. The TI allowance is $30.00/RSF, and there is a 6% total lease commission, calculated on the gross rent. The present value of the rental income, including the abatement period, is $103.05/RSF. If you amortize this amount over a 66-month period, the PV Constant rental rate is $23.07/RSF. Now, you deduct the amortized value of the $30/RSF TI allowance and the 6% commission, which totals $9.57/RSF. The net effective rate to the landlord is $13.50/RSF.
|If you are the tenant, why should you care what the landlord’s NER is?
The NER allows you to easily compare leases that have different lease terms and other variables. This NER of $13.50/RSF may be above or below market, depending upon the current conditions. A landlord monitors the NERs they negotiate on each transaction, with the goal of negotiating a rate that is at or above what they consider to be “market” at any given time. If you want to know if your deal is “at market,” the best approach is to obtain the terms from similar transactions in the marketplace and calculate the NER for those transactions. This information is not readily available; however, brokers are continually gathering as much of this information as they can obtain. If you are getting proposals from more than one similar building, you can compare the NERs for those proposals. The state of the market, the location, the quality of the building and the quality of the leasable premises are some of the factors which influence what is market for a particular space.