One warehouse letting with 1,850,000 of landlord works, run three ways, and the split between permanent improvement and true incentive that decides which figure is evidence.
Net effective rent is the headline rent less the landlord's incentive spread over the period the tenant is committed for, ideally discounted at a rate. On an illustrative 12,000 m² warehouse let at 96.00 per m² for ten years with a 1,850,000 landlord contribution, the three common methods give 80.58, 75.05 and 86.94 per m², and only the last, which spreads just the part of the contribution that bought nothing permanent, is evidence of market rent.
Worked in full in Logistics and Industrial Real Estate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Industrial leases rarely come with a plain rent-free period alone. The landlord pays for dock levellers, resurfaces the yard, fits out the office block to the tenant's taste and puts in power for its equipment. Every one of those cheques reduces what the landlord really earns, but not every one is an incentive. Getting the split wrong moves the rent you quote as evidence by more than ten per cent. That classification of landlord's works, rather than the annuity arithmetic of the generic office case of rent-free and fit-out over the term certain, is what an industrial net effective rent turns on.
| Item | Amount | Per m² | Permanent improvement? |
|---|---|---|---|
| Floor area, m² | 12,000 | ||
| Headline rent a year (96.00 per m²) | 1,152,000 | 96.00 | |
| Term, no break | 10 years | ||
| Dock levellers | 620,000 | 51.67 | Yes |
| Yard resurfacing | 430,000 | 35.83 | Yes |
| Office refit to the tenant's specification | 520,000 | 43.33 | No |
| Specialist power and floor coatings | 280,000 | 23.33 | No |
| Total landlord contribution | 1,850,000 | 154.17 |
The discount rate is 6 per cent and income is taken annually in arrears, the conservative convention. The contribution equals 19.3 months of headline rent, which is how agents usually describe it, but the months figure hides the question that matters: what did each line buy?
NER = headline − contribution / years committed
1,152,000 − 1,850,000 / 10 = 1,152,000 − 185,000 = 967,000, or 80.58 per m². In Excel: =(96*12000-1850000/10)/12000.
This is the quick convention many brokers quote. It ignores timing: the landlord pays the 1,850,000 on day one and recovers it over ten years, so a pound spread in year ten is treated as if it were worth a pound today.
NER = headline − contribution / annuity factor(rate, years)
The ten-year annuity factor at 6 per cent is (1 − 1.06−10) / 0.06 = 7.3601. 1,850,000 / 7.3601 = 251,356 a year, so NER = 1,152,000 − 251,356 = 900,644, or 75.05 per m². In Excel: =96-1850000/PV(6%,10,-1)/12000.
Discounting is right in principle and lowers the figure by 5.53 per m² against method 1. But it treats the dock levellers and the new yard as if the landlord had simply handed the tenant cash. They will still be there when the lease ends, and the next occupier will pay for them in its rent.
NER = headline − occupier-specific spend / annuity factor
Only the office refit and the specialist power, 800,000, are an incentive: 43.2 per cent of the contribution. 800,000 / 7.3601 = 108,694 a year, so NER = 1,152,000 − 108,694 = 1,043,306, or 86.94 per m². The other 1,050,000 is capital expenditure on the building, and belongs in the valuation as capex, not in the rent analysis.
| Method | Annual | Per m² | Below headline |
|---|---|---|---|
| Headline | 1,152,000 | 96.00 | |
| 1. Straight-line, whole contribution | 967,000 | 80.58 | 16.1% |
| 2. Discounted, whole contribution | 900,644 | 75.05 | 21.8% |
| 3. Discounted, incentive only | 1,043,306 | 86.94 | 9.4% |
The evidence figure is neither the 96.00 the landlord will announce nor the 75.05 a sceptical neighbour might compute. The 11.89 per m² between methods 2 and 3 is 142,661 a year on this unit; capitalised at an illustrative 5.75 per cent it is 2,481,067 of value on a building next door that uses this letting as its comparable.
The single most common error is spreading the incentive over the term when the tenant can walk out earlier. The commitment period is the term to the first break. Put a year-five break into the same lease and method 3 becomes 1,152,000 − 800,000 / 4.2124 = 962,083, or 80.17 per m². Spreading over ten years instead overstates the net effective rent by 6.77 per m², 8.4 per cent.
| Discount rate | 10-year annuity | Method 2 | Method 3 | Method 3, break at year 5 |
|---|---|---|---|---|
| 4% | 8.1109 | 76.99 | 87.78 | 81.02 |
| 5% | 7.7217 | 76.03 | 87.37 | 80.60 |
| 6% | 7.3601 | 75.05 | 86.94 | 80.17 |
| 7% | 7.0236 | 74.05 | 86.51 | 79.74 |
| 8% | 6.7101 | 73.02 | 86.06 | 79.30 |
The rate matters less than people argue about: four points of discount rate move method 3 by 1.72 per m². The break moves it by 6.77, and the classification of the contribution by 11.89. Spend the negotiation where the money is.
A rent-free period is always an incentive: it buys the building nothing. Value it as the headline rent foregone, discounted from the months it covers, and add it to the occupier-specific spend before dividing by the annuity factor.
To solve the problem the other way, the headline that delivers a net effective rent you are prepared to underwrite, see what headline rent delivers a target net effective rent; the net effective rent calculator runs both directions.
Net effective rent is headline minus incentive over the committed period, discounted. On this warehouse that is 86.94 per m², 9.4 per cent below the headline, provided the 1,050,000 of permanent improvements is kept out of the incentive. The same lease, cube parity and the uplift sheets sit in the free workbook for this case, with every input live so you can paste in your own letting.
Discounted is more correct, because the landlord pays the incentive up front and recovers it over time. On a 1,850,000 contribution over ten years at 6 per cent the annual charge is 251,356, against 185,000 straight-line, so the discounted net effective rent is 5.53 per m² lower. Whichever you choose, apply the same convention to every comparable.
Only the part with no value after the tenant leaves. Dock levellers and yard resurfacing, 1,050,000 here, are permanent improvements a successor occupier pays for. An office refit and specialist power, 800,000, are occupier-specific and are the true incentive. Spreading only the 800,000 gives 86.94 per m² instead of 75.05.
To the first break, because that is all the tenant committed to. With a year-five break the 800,000 incentive spread over a five-year annuity factor of 4.2124 gives 80.17 per m². Spreading it over ten years would show 86.94, an overstatement of 8.4 per cent.
This article is one calculation from Logistics and Industrial 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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