The business plan underwrites a net effective rent; the negotiation is about a headline and a package. Work backwards from one to the other.
Net effective rent is linear in the headline, so you can solve for the headline directly: add the present value of the incentives to the present value of the target net effective rent over the term certain, then divide by the present value of the rent actually paid. To bank a net effective rent of 300 per m² on an illustrative office letting with nine months rent-free, a 100 per m² fit-out contribution and fees of 15 per cent of a year's rent, all to a five-year break, the headline must be 405.84 per m², 35.3 per cent higher.
Worked in full in Office Real Estate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Most net effective rent calculations run forwards: here is the deal, what does it net? The question an office landlord actually has before a negotiation runs backwards. The business plan underwrites a net effective rent; the agent will negotiate a headline and a package of incentives. Which headlines, with which packages, deliver the plan?
| Input | Value |
|---|---|
| Target net effective rent, per m² a year | 300 |
| Lease length | 10 years |
| Tenant break, so term certain | 5 years (60 months) |
| Rent-free period | 9 months |
| Landlord fit-out contribution, paid at start | 100 |
| Agency and legal fees, paid at start | 15% of a year's headline |
| Discount rate | 6% |
| Floor area let | 4,000 m² |
The incentives are spread over the term certain, the 60 months to the tenant's break, because that is the period over which the landlord is sure of receiving rent. Spreading them over the full ten years is the most common way of overstating a net effective rent, and it is tested below.
NER = [H × PV(rent paid) − contribution − fee% × H] ÷ PV(annuity over term certain)
Solve for H: H = [NER × PV(annuity) + contribution] ÷ [PV(rent paid) − fee%]
With a monthly rate of 0.4868 per cent (6 per cent a year), the PV of 1 a year paid monthly over 60 months is 4.3270, and over months 10 to 60, after the nine months rent-free, it is 3.5949. In Excel, =PV(r,60,-1/12) gives the first factor and =PV(r,60,-1/12)-PV(r,9,-1/12) the second.
Substituting: H = (300 × 4.3270 + 100) ÷ (3.5949 − 0.15) = 405.84.
Check it forwards. A headline of 405.84 gives 1,458.97 of rent in present value. Deduct fees of 60.88 and the 100 contribution and the landlord keeps 1,298.10 per m². Divided by the annuity factor of 4.3270 that is exactly 300.00 a year. Across 4,000 m², the lease will be reported at a headline of 1,623,372 a year and is worth the same as a lease at 1,200,000 with no incentives. The net effective rent is 73.9 per cent of the headline.
| Rent-free | Headline, 5-year term certain | Premium | Headline, 10-year term certain | Premium |
|---|---|---|---|---|
| None | 334.71 | 11.6% | 319.57 | 6.5% |
| 6 months | 379.36 | 26.5% | 342.27 | 14.1% |
| 9 months | 405.84 | 35.3% | 354.60 | 18.2% |
| 12 months | 435.83 | 45.3% | 367.64 | 22.5% |
| 18 months | 509.48 | 69.8% | 396.17 | 32.1% |
Two patterns are worth remembering. On a five-year term certain each extra three months of rent-free adds from about 22 to 37 per m² to the required headline, and the increments grow, because every month given away also shortens the period over which the remaining incentives are recovered. And removing the break roughly halves the headline premium at every level of incentive. That is the arithmetic behind the landlord's preference for a longer term certain at a lower headline: the tenant's break is the most expensive incentive in the package and it never appears in the list of incentives.
The fit-out contribution behaves more simply. Each 100 per m² adds 29.03 to the required headline: 376.81 with no contribution, 405.84 at 100 and 434.87 at 200.
Spreading the incentives over the full lease. Solve on ten years instead of the five-year term certain and the required headline drops to 354.60. Let at that headline, the lease actually delivers 259.20 to the break, a shortfall of 40.80 per m² a year against the plan. The tenant who negotiated the break did so precisely to keep that option.
Ignoring the time value of money. The straight-line version, rent received less incentives divided by five years, gives a required headline of 390.24. Let at 390.24, the discounted net effective rent is 287.58, 12.42 per m² a year short, or 49,677 a year across the floor. The rent-free and the contribution are paid at the start and the rent arrives later, so undiscounted arithmetic always flatters the landlord. The gap widens with the size of the package and the discount rate.
Reading a headline as evidence. A headline of 380 on a five-year term certain with this package nets only 279.43. When a comparable letting is quoted, convert it to net effective on its own term certain before using it to support anything, including your own valuation.
Work backwards from the net effective rent the plan needs. Here it takes a headline of 405.84 to bank 300 to a five-year break, and the same package on a ten-year term certain would need only 354.60. The free headline to net effective rent workbook runs the calculation in both directions, and the net effective rent calculator converts a single lease either way.
Because net effective rent is linear in the headline, solve directly: headline = (target NER times the PV annuity factor over the term certain, plus upfront incentives) divided by (the PV factor of the rent actually paid, less fees as a fraction of rent). On the illustrative office, (300 x 4.3270 + 100) / (3.5949 - 0.15) gives 405.84 per m².
To the first tenant break, the term certain, because that is the only income the landlord is sure of. On an illustrative ten-year lease with a five-year break, solving to expiry gives a headline of 354.60 for a 300 target; let at that level, the lease delivers only 259.20 to the break.
It overstates the landlord's position, because rent-free periods and contributions are paid before the rent arrives. In the illustrative case the straight-line method says a 390.24 headline delivers 300; discounted at 6 per cent it delivers 287.58, a shortfall of 12.42 per m² a year, or 49,677 a year on 4,000 m².
This article is one calculation from Office Real Estate. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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