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Why is the Net Effective Rate Important When Evaluating Different Options?


When searching for the right commercial space, many people focus on the "face rate" or the asking rate at a particular building. The proposed rental rate is only a starting point for negotiations and doesn’t include the full financial picture of a lease agreement. However, the true cost of a lease can be better understood by focusing on the “net effective rent," a more nuanced metric that considers other factors, such as rent-free periods and tenant improvement allowances.


What is Effective Rent?

Effective rent is the actual cost per square foot that a tenant will pay over the term of the lease, factoring in all concessions. In essence, it's an average rate that accounts for not just what you pay, but what you receive in value from the landlord.



Why is that Important?

While asking rates might be increasing, a focus on net effective rent reveals that the true cost to tenants may be decreasing due to generous concessions from landlords. This divergence between face rates and effective rates is particularly evident post-pandemic, with landlords offering substantial allowances to attract or retain tenants. This is particularly evident in competitive markets, like the Greater Boston area.


A Realistic Picture of Costs


Net effective rent gives you a more realistic picture of your ongoing costs. For example, one property might have a higher asking rate but comes with several months of free rent, or a significantly higher tenant improvement (T.I.) allowance. At the other end of the spectrum, another property might have a low asking rate with little to no concessions included. For example, if a perspective tenant is looking to make improvements to the space, that tenant would need to come out of pocket to cover those costs. Calculating the net effective rent for both options often surprises tenants, showing that the seemingly more expensive property may be more cost-effective over time.


Comparing Apples to Apples


When you’re comparing different lease options, you want to ensure you’re making an "apples-to-apples" comparison. Each property may offer different amenities, lease structures, and concessions. Effective rent allows you to normalize these variables into a single, comparable figure.


Future Planning and Budgeting


Understanding the effective rent can help businesses plan their budgets more accurately. It provides a detailed picture of the lease's financial burden, aiding in both the immediate decision-making and longer-term financial strategies.


Conclusion

While the “face rate” or asking rate is a significant factor, it should not be the sole element in the decision-making process. Effective rent provides a more accurate, holistic view of the true cost of a lease. It ensures that you are fully informed, helping you to negotiate better terms and make a choice that aligns with the company’s financial goals moving forward.


Although Net Effective rent is not the only factor that should influence a clients’ decision but an important one. At WRA we believe that the most informed decision is often the best decision.

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