Free Rent and Concessions: Effect on Effective Rent

Free rent lowers the cash a lease produces without changing the stated rate, so effective rent sits below face rent whenever a concession exists. Spreading the abated rent across the full term, and in some definitions the tenant improvements and leasing commissions as well, gives an average that supports comparison. That average hides timing, because the free months and the upfront costs land at the start of the lease, when cash is thinnest.

What an effective rent figure counts and what it leaves out

Effective rent is face rent after concessions and escalations have been accounted for across the lease term. The headline rate is the rent stated in the lease. The effective rate is what remains once abated months are removed and the result is averaged over the whole term.

Definitions differ at the edges. In some markets broker commissions sit inside the effective rent calculation, and in others they do not. Two quotes that both carry the label effective can therefore deduct different costs.

The mechanics run in a fixed order. Scheduled rent is summed for every period of the term, abated months come out, and the remaining receipts are divided by the term in years. Dividing again by the leased area produces a rate per square foot per year. If the definition in use also covers tenant improvements and commissions, those come out before the division.

The phrase net effective rent usually signals a version that deducts more than a simple concession average. The label alone never says which costs were deducted, so the numerator has to be read from the calculation itself.

“Effective rent calculations may vary according to local market practices; for example, in some markets, broker commissions are included.”

“Beyond the rent roll, scrutinize the actual collections, including a trailing 12 months (T12) of income and expenses. Review the net effective rent, which accounts for concessions and discounts that affect the rent figures.”

One free month on a twelve month apartment lease

A unit listed at $2,000 a month on a 12 month lease with one month free yields $22,000 over the year, which is $2,000 below the $24,000 the listing implies.

The same concession weighs differently by lease length. One free month removes a full twelfth of a 12 month lease. On a 24 month lease the same month removes one twenty-fourth, so the effective rate falls by half as much.

Concessions also move with demand, which makes effective rent growth a two part number. In one multifamily project, effective rents grew 45.4 percent over twelve months as asking rents rose and upfront concessions fell. A rise in effective rent can come from the rate, from the concession, or from both, and the headline asking rent shows only one of them.

In a soft period, two months free was common in one market, and that practice stopped overnight once demand returned. Leases signed under heavy concessions carry face rents that overstate what those tenants actually paid.

Where the free months fall relative to rent steps

An abated month carries the rent scheduled for that month. When rent steps up during the term, the nominal value of a free month depends on where it sits, and multiplying every free month by the opening rate misstates the concession whenever a step precedes the abatement.

Scope matters as much as placement. A concession that abates base rent leaves other billed charges outside the concession. A model that zeroes the entire monthly invoice during the free period overstates what the landlord gave up.

Equal nominal concessions can sit in different places. Free months at commencement and free months spread across later years remove the same total dollars, and an undiscounted average treats them alike. A discounted comparison gives earlier dollars more weight, so the front-loaded version costs the landlord more in present value terms.

Escalations pull the other way. Because effective rent accounts for both concessions and escalations, a lease with steps can show an effective rate close to a flat lease with no abatement. The two leases still collect very different cash in the opening year.

Worked example: six versus nine months of free rent on a 10,000 square foot office lease

This hypothetical comparison uses the same 10,000 square feet, a five year term and flat base rent of $30 per square foot per year in both cases. Both cases carry a tenant improvement allowance of $20 per square foot and a $60,000 leasing commission, both paid at commencement. Escalations, expense reimbursements and discounting are left out so that only the concession differs. The term is 5 multiplied by 12, or 60 months.

Scheduled annual base rent is 10,000 multiplied by $30, or $300,000. Monthly rent is $300,000 divided by 12, or $25,000. Rent over the full term is $300,000 multiplied by 5, or $1,500,000.

Base case, six months free. Free rent is $25,000 multiplied by 6, or $150,000. Receipts are $1,500,000 minus $150,000, or $1,350,000. Averaged over 5 years that is $270,000 a year, and divided by 10,000 square feet the rent-only effective rent is $27 per square foot per year. That is $3 below the face rate.

Alternative case, nine months free. Free rent is $25,000 multiplied by 9, or $225,000. Receipts are $1,500,000 minus $225,000, or $1,275,000. Averaged over 5 years that is $255,000 a year, and the rent-only effective rent is $25.50 per square foot per year, which is $4.50 below the face rate.

Now the leasing costs. The allowance is 10,000 multiplied by $20, or $200,000. Adding the $60,000 commission gives $260,000 of upfront costs in both cases.

Base case after those costs: $1,350,000 minus $260,000 is $1,090,000. Divided by 5 that is $218,000 a year, or $21.80 per square foot per year, $8.20 below face. Alternative case: $1,275,000 minus $260,000 is $1,015,000. Divided by 5 that is $203,000 a year, or $20.30 per square foot per year, $9.70 below face.

The three extra free months cost $1,090,000 minus $1,015,000, or $75,000 in total. That is $15,000 a year, or $1.50 per square foot per year, on the same lease with the same face rate.

Opening year cash tells a different story from either average. Base rent collected in year one is $300,000 minus $150,000, or $150,000 in the base case, and $300,000 minus $225,000, or $75,000 in the alternative. Against $260,000 of upfront costs, the landlord funds $260,000 minus $150,000, or $110,000, in the base case and $260,000 minus $75,000, or $185,000, in the alternative.

Both leases show a positive average effective rent, and both require cash funding in year one. The average spreads the costs across five years, and the payment dates stay where they are.

Why annualized contractual rent and trailing collections disagree

Some reporting measures annualize the first rent payable after a free rent period ends. That measure reads the full contractual run rate and says nothing about the cash received while the abatement runs. In the worked example both cases show a $300,000 run rate, while year one collections are $150,000 and $75,000.

Collections tell the other half. A trailing 12 month review of actual income and expenses, read alongside net effective rent, can show that an asset generated less income than the rent roll suggests. The rent roll lists contractual terms, and the collections record shows what was paid.

Lease comparables add a further gap. Comps may leave out free rent and tenant improvement details, and an effective rent derived from a comp with missing terms is incomplete by exactly those terms. A face rate on a comp can look like a clean data point while the concession package behind it is unknown.

Why office concessions weigh more than apartment concessions

Office leases add a cost layer on top of free rent. High tenant improvement and leasing commission costs can make re-tenanting hard to justify at an older basis as net effective rents fall. A rent-only comparison omits that layer entirely, which is why the cost-adjusted figure in the worked example sits so far below the rent-only figure.

In retail, stronger tenant bargaining power can pressure rents and occupancy and push landlords toward higher tenant improvement spending or lease concessions. The stated rent captures only part of the movement.

Apartment concessions take the form of free months on a short lease, so the effect lands in the opening period and ends with the lease. They can shift quickly with demand, and an effective rent series built across such a shift mixes two different concession regimes.

Mistakes that overstate or understate lease income

Treating annualized post-abatement rent as current collections erases the concession period. The annualized figure correctly describes the contractual rate after the free months end. It overstates cash received while those months run, and in the example it overstates year one collections by $150,000 in the base case and $225,000 in the alternative.

Deducting free rent twice is possible in layered models. An effective rent already averages the abated months into the rate. Subtracting the abatement again from that figure, or from a rent roll that already shows the net rate, counts the same concession two times.

Comparing effective rents with different numerators distorts every comparison built on them. A figure that includes commissions and a figure that excludes them are different measures, so a gap between two quotes can be a definitional gap and carry no information about the leases.

Reading the average as a cash position hides the funding need. The example shows $21.80 per square foot of cost-adjusted effective rent in the base case while the landlord still funds $110,000 in year one. Averaging spreads the cost without moving the payment.

Valuing every free month at the opening rate overstates the concession when a step falls between lease start and the abated month, and understates it in the reverse case. A schedule built period by period shows the rent each abated month actually carried.

Checklist questions for reconciling concessions to lease income

What does the quoted effective rent deduct? A defined numerator shows whether only rent concessions are included or whether tenant improvements and commissions are also counted.

Which payments does the abatement cover? Only the charges named in the concession belong in its dollar value.

Where does each free period sit against the rent steps? The rent scheduled for that month sets the size of the reduction.

What term and area basis form the denominator? Comparable rates need the same years and the same square footage convention.

When are allowances and commissions paid? The payment dates set the funding need even when the effective rent spreads those costs across the term.

Does the annualized rent figure start after the free period? That starting point explains the gap between contractual run rate and collections.

How do trailing collections reconcile with the lease schedule? A bridge separates abatement inside the window from any other shortfall between rent due and rent paid.

Which concession terms are missing from the comparable? Absent free rent or improvement terms leave the effective rent on that comp unresolved.