Net Effective Rent (NER) Underwriting: Concessions & TI Deductions
Evaluating commercial leases solely based on contract face rent creates dangerous distortions in Net Operating Income (NOI). Calculating Net Effective Rent (NER) normalizes lease revenues by deducting free rent abatement, tenant improvement (TI) allowances, and leasing broker commissions over the lease term.
Key Financing Parameters & Standards
Institutional Market Reference
Face Rent DefinitionContractual monthly/annual rent stated on the face of the lease agreement
Net Effective Rent (NER) Formula(Total Lease Rent Collected - Free Rent - Landlord TI - Leasing Commissions) ÷ Lease Term in Months
Discounted NER MethodPresent value of net monthly cash flows discounted at property discount rate (6% to 9%)
Tenant Improvement Impact$30 to $80/SF TI allowances consume 15% to 35% of total cumulative lease revenue
Leasing Commission Impact4% to 6% of gross lease value paid to tenant rep and landlord listing brokers
Lender Underwriting PolicyLenders capitalize NER or deduct ongoing amortized leasing capital expenditures from NOI
* NER calculations must account for annual contract escalation percentages (typically 2.5% to 3.5% or CPI).
Why Face Rent Masks True Property Cash Flows
In competitive office and retail markets, landlords frequently inflate contract face rent to achieve high headline numbers for lenders and appraisers, while quietly granting massive concessions behind the scenes.
For example, a landlord might sign a 5-year lease at $40.00/SF. However, to induce the tenant to sign, the landlord grants 6 months of free rent, provides a $50.00/SF cash tenant improvement allowance, and pays a $12.00/SF broker commission. While the lease appears to pay $40/SF, the landlord’s actual net cash realization is dramatically lower.
The Mathematical Net Effective Rent (NER) Formula
Under the straight-line method, NER is calculated as total net economic collections divided by lease duration:
1. Gross Lease Value (60 Months at $40/SF on 10,000 SF): $2,000,000.
2. Less 6 Months Free Rent Abatement: -$200,000.
3. Less Landlord TI Allowance ($50/SF): -$500,000.
4. Less Broker Commissions (5% of Gross): -$100,000.
The true economic yield is $24.00/SF—a 40% reduction from the reported $40.00/SF face rent.
How Commercial Lenders Capitalize NER into Loan Sizing
Institutional underwriters do not size permanent debt on unadjusted face rents. Lenders either: (1) Replace contract rent with calculated NER in their financial model; or (2) Underwrite face rent but deduct an ongoing normalized capital reserve for future tenant improvements and leasing commissions (TI/LC reserve) of $1.50 to $3.50/SF annually directly from property NOI.
Frequently Answered Questions
Common Questions About Net Effective Rent (NER) Underwriting: Concessions & TI Deductions
Direct, transparent answers regarding underwriting standards, documentation, and process.
NER Formula
What is Net Effective Rent (NER) in commercial real estate?
Direct Answer
Net Effective Rent (NER) is the true economic rent earned by a landlord after subtracting the value of all tenant concessions, free rent periods, tenant improvement allowances, and leasing commissions over the lease term.
It measures actual net cash flow rather than top-line face rent stated in the lease.
Lender Treatment
How do commercial lenders treat tenant improvement allowances when sizing loans?
Direct Answer
Lenders account for TI allowances by either underwritten Net Effective Rent or establishing a mandatory ongoing TI/LC replacement reserve deducted directly from property NOI before calculating DSCR.
This ensures sufficient cash flow exists to re-tenant spaces upon lease rollover.
Concession Amortization
Why do landlords offer free rent instead of lowering the face rent?
Direct Answer
Landlords prefer free rent because preserving a high contract face rent maintains higher headline property valuations under capitalization rate formulas and avoids establishing a lower rent comparable in the submarket.
However, underwriters look through this strategy by calculating Net Effective Rent.
Connect with our commercial underwriting team. We provide prompt indicative pricing, leverage sizing, and lender placement strategy upon scenario review.
