Net Rent, Gross Rent & Net Effective Rent

Question:

What’s the difference between Net Rent, Gross Rent and Net Effective Rent (NER)?

Answer:

It’s important to view the terminology in context of the entire document (which is generally an Offer to Lease or a Formal Lease / Standard Lease). In the Greater Edmonton market, the term Net Rent generally implies that the tenant pays rent plus property taxes, building insurance, common area maintenance and management fees (which is called Additional Rent or Operating Costs). Generally, a Landlord will estimate the expenses to operate the building at the beginning of the year. After all bills have been paid, the landlord will reconcile the amount collected with the amount expensed. After the reconciliation, the Landlord should credit the tenant if they estimated too high, or invoice the tenant if they underestimated expenses. While it may vary in other markets, from our own anecdotal knowledge, we recommend anticipating the Additional Rent to rise each year as it’s not overly common to see those costs decrease.

Here is an example of how rent is often quoted for commercial properties in Edmonton:

10,000 square foot building, $10.00 / sq ft Net + $5.00 / sq ft for Additional Rent (2017 estimate).

The rent per square foot is calculated on an annual basis so the rent in this example would be $150,000 (10,000 sq ft * $15.00 / sq ft). To calculate the monthly rent, simply divide by 12 to get $12,500 ([10,000 sq ft * $15.00 / sq ft] / 12 months). We noted above, but it’s worth emphasizing, that the Additional Rent component of this monthly amount will vary (read: increase) each year, so budget accordingly.

Gross Rent, which is common in residential but uncommon in commercial, is rent that infers that all operating costs are included. Given the unpredictable nature of the operating expenses for a building, most landlords are reluctant to lease space on a gross basis (unless it’s a shorter term). We have seen some landlords quote gross leases but we remind tenants to read the entire document carefully. Even these purported gross leases have a provision that the operating expenses are established on a base year with any increases passed through to the tenant. Ultimately, this creates the same effect as a net lease.

For multi-tenant buildings, landlord’s tend to charge additional rent based on the tenant’s proportionate share of the building. In a simple example, a 10,000 square foot building with four tenants each occupying 2,500 square feet, the Additional Rent would be allocated such that each tenant pays 25% of the costs.

Net Effective Rent, is a different concept altogether, but equally as important to tenants and landlords alike. This is another term that could have numerous interpretations so we’ll present the one we find most common in our market. Total Net Effective Rent (sometimes referred to as Effective Rent), is the total amount of net rent that a tenant pays over the term of the lease. Using the previous example, if the tenant pays $10.00 / square foot for 10,000 square foot building on a 5 year term, it would pay $500,000 over the term (10,000 square feet * $10.00 / square foot * 5 years). This does not take into account any free rent or tenant incentives. For example, if the tenant received 3 months free rent at the beginning of the lease, the net effective rent would be $475,000 ([[10,000 square feet * $10.00 / square foot] / 12]] * 57 months). Dividing this amount by the square footage of the building and the term of the lease yields the Net Effective Rate, which in this case will be $9.50 / square foot ($475,000 / 10,000 square feet / 5 years). The benefit of this additional calculation will be to accurately compare different lease options. In other words, if a tenant is looking at two options, it will be important to compare the Net Effective Rate instead of just the posted Net Rent. All other things being equal, if one option has a posted rate of $9.75 / square foot but does not offer any free rent, it will be more economical for the tenant to choose the $10.00 / square foot option that offers 3 months of free rent.  It’s comparing apples to apples, so to speak.  It’s worth noting that Landlord’s may adjust their Net Effective Rent calculations by adding other expenses (such as tenant improvements and leasing commissions).

There are numerous terms that get tossed around, including net rent, gross rent, net net rent, triple net rent, modified gross rent, net effective rent, effective rent, face rent and contract rent. While we wrote this to provide an overview of some lease terminology, we emphasize that tenants need to fully understand what is being implied and how it is defined within the full context of the lease document. We always encourage tenants and landlords to get independent legal and accounting advice.

 


 

Disclaimer

This is not intended to be construed as legal or accounting advice and does not form part of any future contract. Information and definitions contained herein reflect our sole opinions and are subject to change without notice. Readers should independently verify and research the terminology before acting on anything contained herein and the content may also not be accurate in other markets. We strongly recommend and encourage readers to obtain independent legal and accounting advice.

Our Team

Chad Griffiths

Chad Griffiths

SIOR, CCIM

Chad is a partner with NAI Commercial Real Estate and focuses on the Greater Edmonton area. Chad entered the industry in 2004 and has completed over 400 commercial transactions with clients ranging from small, local companies to large institutional owners. Chad has been a top 15 producer Canada-wide since 2013.

Ryan Brown

Ryan Brown

BCom, SIOR

Ryan is a partner with NAI Commercial Real Estate in Edmonton. He is currently ranked nationally as one of NAI's top advisors in Canada. Having executed in excess of $100 Million dollars worth of sales transactions and over 2 Million square feet of lease transactions, Ryan has developed a firm understanding of asset evaluation and an aptitude for building design, functionality, and practicality for long term use.

Darcie Bouteiller

Darcie Bouteiller

Darcie is a licensed Commercial Real Estate Agent in the Province of Alberta with a focus on the Edmonton market and its surrounding areas. Darcie accomplishes custom solutions for her clients through her personable nature and results driven attitude. Darcie can help if you are looking to invest in commercial real estate or are looking for representation for a sale or lease transactions.

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