A Fresh Take on CRE

Asking Rents & Even Taking Rents Don't Tell The Full Story

In some of my recent posts (ok, not that recent) I've shared some of Grubb & Ellis' research on what's going on with the market. Many people have mentioned to me, that they are suprised by how little asking rents have dropped. With that mind, I thought now would be a good time to talk about Net Effective Rents.




Net Effective Rents are simply, the rent that a lessee or sublessee pays once you "net out" all of the concessions made by the landlord or sublandlord and average out the rent bumps. Here's an example:

Joe makes a deal on a space in Midtown. The landlord on the space is asking $70 a SF (per year) for a 10,000 SF space. Joe likes it, but recognizes that this rent is much higher than the current market for that kind of space. Joe's astute broker, Michael realizes that the landlord is under pressure from his investors to rent his space for as high a price as possible. He suggests to Joe, that he put in an offer close to the asking price but with lots of concessions to bring the overall cost down.

Ultimately, Michael negotiates a 10 year deal for Joe where he pays $65 a foot for the first 5 years and $67 a foot for the second 5 years. Joe will also get $75 a foot in Tenant Installation allowance, and 10 months free rent.
Joe's new landlord goes back to his investors and tells them that he made a deal with an average rent of $66. Not far off his asking price of $70. However, let's look at the Net Effective Rent, shall we?:

The value of 10 Months free rent: $5.42/SF

The value of $75 a foot in TI (Tenant Installation $): $7.50/SF
Net Effective Rent: Average of $65 for 5 years and $67 for 5 years = $66 - $5.42 free rent - $7.50 TI = $53.08


Now, this is obviously a simplified model, as I didn't account for the time value of money. If I did, you would find that the landlord did even worse. I also made the assumption that all of the free rent was up front, which is not always the case, and I assumed that the term wasn't extended to account for the free rent.


The point of this example was to show you, what's really happening in the NY market right now. Asking rents may only be down 3.7% from their peak, but taking rents are down 9% and net effective rents are down 12.6%. This trend will surely continue well in to 2009 and expect to see much larger discounts on sublets than on direct space.

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