Four office lettings with different incentives turned into one estimated rental value for a vacant floor, step by step, with the rent-free assumption that moves it most.
To derive ERV from comparables, devalue each letting to a net effective rent over its term certain, adjust it for rental growth since the letting and for its differences from your building, average the results, then re-gear that net figure to the headline your building would achieve on market terms. Four illustrative office lettings average 46.30 per sq ft net effective; with 15 months rent-free on a ten-year term, the headline ERV is 52.92, call it 53.00, against an average headline of 51.38.
Worked in full in The Real Estate Asset Manager by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
ERV sits under almost every number an asset manager reports: the reversion, the equivalent yield, the business plan's letting assumptions and the valuer's figure at the quarter end. It is also the number most often lifted from a broker's email without the incentives that came with it. The method below is the one valuers use; the asset manager's job is to be able to rebuild it and challenge each step.
| Letting | Headline | Term certain (months) | Rent-free (months) | Months ago | Difference from subject |
|---|---|---|---|---|---|
| Letting 1 | 52.50 | 120 | 18 | 6 | Comparable |
| Letting 2 | 48.00 | 60 | 6 | 12 | Inferior specification, +5% |
| Letting 3 | 55.00 | 60 | 9 | 3 | Superior floor and views, −5% |
| Letting 4 | 50.00 | 120 | 12 | 18 | Larger floor, quantum, +3% |
The subject is a vacant 20,000 sq ft floor. Rental growth since each letting is taken at 3 per cent a year, illustratively. Term certain means to the first break: letting 3 is a ten-year lease with a break at five, so its incentive is analysed over 60 months.
NER = headline × (term certain − rent-free) / term certain
Letting 1: 52.50 × 102 / 120 = 44.625. In Excel: =B2*(C2-D2)/C2. This is the straight-line convention most valuers quote; a discounted version spreads the incentive at a rate and gives a slightly different figure, so use the same convention for every comparable and for the subject.
Adjusted NER = NER × (1 + growth)months / 12 × (1 + difference adjustment)
Letting 4: 45.00 × 1.031.5 × 1.03 = 45.00 × 1.0453 × 1.03 = 48.45. In Excel: =F2*(1+3%)^(E2/12)*(1+G2).
| Letting | Headline | Incentive share | NER | Time uplift | Adjusted NER |
|---|---|---|---|---|---|
| Letting 1 | 52.50 | 15.0% | 44.62 | 1.49% | 45.29 |
| Letting 2 | 48.00 | 10.0% | 43.20 | 3.00% | 46.72 |
| Letting 3 | 55.00 | 15.0% | 46.75 | 0.74% | 44.74 |
| Letting 4 | 50.00 | 10.0% | 45.00 | 4.53% | 48.45 |
| Average | 51.38 | 44.89 | 46.30 |
The ranking changes on the way through. Letting 3 has the highest headline, 55.00, and the lowest adjusted rent, 44.74, because its incentive is spread over only five years and its floor is better than the subject's. Letting 2 has the lowest headline and ends second highest. Headlines rank the deals; net effective rents rank the evidence.
A straight average treats the four lettings as equally reliable. Weighting them 40, 20, 30 and 10 per cent towards the most comparable and most recent gives 45.73 net and a 52.26 headline. Whichever you choose, write the weights down; the valuer will have chosen some.
ERV is quoted as a headline rent, so the evidenced net figure has to be grossed back up with the incentive a tenant would expect on the subject today, here 15 months on a ten-year term:
Headline ERV = NER × term / (term − rent-free) = 46.30 × 120 / 105 = 52.92
On 20,000 sq ft: 1,058,305 a year headline, 926,017 net effective. Most valuers would round to 53.00.
| Rent-free (months) | Headline ERV | Above NER | On 20,000 sq ft |
|---|---|---|---|
| 9 | 50.05 | 8.1% | 1,001,100 |
| 12 | 51.45 | 11.1% | 1,028,908 |
| 15 | 52.92 | 14.3% | 1,058,305 |
| 18 | 54.47 | 17.6% | 1,089,432 |
| 21 | 56.12 | 21.2% | 1,122,445 |
The incentive assumption moves the ERV by 6.07 per sq ft across this range without changing what a tenant would actually pay. That is why an ERV quoted without its incentive package cannot be compared with passing rent, and why the reversionary potential of a building should be tested on net effective rents as well as headlines.
Each adjustment is a judgement, and the valuer's are rarely printed. The time uplift assumes 3 per cent a year of rental growth; in a falling market the sign reverses, and an 18-month-old letting then argues for a lower ERV, not a higher one. The specification and quantum adjustments of plus or minus 3 to 5 per cent are worth 1.4 to 2.3 per sq ft on this floor. Ask for the adjustment grid, recompute the average, and check which single comparable moves the answer most: here dropping letting 4 alone takes the net figure from 46.30 to 45.58.
ERV is a net effective rent from the evidence, adjusted for time and differences, re-geared to today's incentive: 46.30 net and 52.92 headline on this case. Keep the three steps visible and every argument about ERV becomes an argument about one input. The Real Estate Asset Manager builds the rent roll around passing rent, ERV and reversion, and the free workbook for this case carries those columns into the business plan.
ERV is the headline rent a property would let for on market terms, with the usual incentive package attached. Net effective rent spreads the incentive across the term: a 52.92 headline with 15 months rent-free on a ten-year term is 46.30 net effective. Comparables must be compared on the net figure, because headlines carry different incentives.
Because each headline buys a different package. Letting 2 here is 48.00 with six months free on five years, letting 1 is 52.50 with eighteen months on ten. Their average of 51.38 is 1.54 per sq ft below the ERV derived on a like-for-like basis, 30,805 a year on a 20,000 sq ft floor, and the error can run either way depending on the mix of incentives.
A lot, because ERV is the headline that delivers the evidenced net effective rent. On a ten-year term, 9 months free gives an ERV of 50.05 per sq ft and 21 months gives 56.12. The net effective rent of 46.30 is the same in both: the valuer's choice of market incentive moves the headline, not the value of the letting.
This article is one calculation from The Real Estate Asset Manager. 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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