Understand Net Effective Rental Rate Helps Lease Negotiation

Net Effective Rental
Use Net Effective Rental Rate To Get A Better Deal

After being in the office leasing business I see many new brokers enter the market to share their experience with their clients. Unfortunately, many of them can show shiny buildings and pretty spaces but their skill level ends at this point.

Ultimately everybody can tour impressive office buildings and get floor plans. A seasoned office tenant representative has learned many skills during their career that creat value for their clients. Today I am going to address a financial term that is used often in the industry but I wonder how many of our understand the concept

Understanding The Net Effective Rental Rate

I say this phrase often but you can get everything in life you want if you just help the other person get what they want. So in order to help you understand the best way to use the effective rental rate in your negotiation you must think like the landlord.

The landlord has many things that he or she must consider when they are analyzing a lease transaction. A few example are:

  • The financial stability of the prospective tenant
  • Overall market rates quoted by other office buildings in the market and how their building is positioned to compete.
  • Budgeted operating expenses to operate the office building
  • Cost of the transaction construction expense, leasing commissions
  • Opportunity Costs how long will the space remain vacant if the landlord doesn’t accept the lease
  • Does the gross rent cover the debt service
  • Do the terms of the offer give the investors the advertised return

So lets take a simple example of a lease analysis in the eyes of a landlord. Your tenant representative has done a good job of negotiating on your behalf and the landlord is now deciding if he should accept your counter offer.

The Landlord has developed the following spreadsheet to compare his options:

Net Effective Rent

In this example the landlord made their offer and by using a some simple calculations your tenant representative can use to determine that the landlord’s net effective rental (NER) they would accept is $13.63 per rentable square foot. The landlord most likely has a desired yield that they must meet and he knows that a net effective rent of $13.63 would the required to achieve the required return.

You have a smart tenant rep that decided to counter the landlord’s offer but give him the same NER. So he had a few contractors bid the construction and determined that the tenant’s plan could be build for $12.00. With a $3.00 reduction in expense to the Landlord the tenant representative decided to reduce the gross rent from $30.00 per foot to $29.37 reducing the tenant’s overall monthly expense. (I am not countering with a lower gross rent but to keep this example simple we are not aggressively negotiating.)

The landlord’s response was to give the tenant a reduction in the gross rent by .25¢ and increase the lease term by a month. He happily took the counters reduction of the tenant improvement allowance by $3.00.

On the surface the landlord appears to have given a little but in reality he has increased the yield for the investors of the property. Notice the net effective rent has increased by .40¢ or 2.9%. By using the net effective rent in your negotiation process you will have insight into what the landlord or his broker is trying to accomplish.

Obviously this is a simplified example that I am using for demonstration purposes. There are other considerations that a landlord will consider. If the market rate is $30.00 per RSF and the tenant couldn’t move to another property and get a rate lower than $30.00 the landlord will match the market rate and use the net effective rental rate as one tool to get the best results for the landlord.

If you are looking for office space for your business. There is more to finding your next lease than touring a building and signing a lease. By using a professional tenant representation broker you can level the playing field and negotiate a fair and good deal for your business and the landlord.

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