What's the Rate

If you look at the quarterly market reports provided by all major real estate service firms (Cushman & Wakefield, included), you will find that rent data is typically expressed in terms of “Asking Rents”.  Reports will cite the trend in Average Asking Rents by submarket, or by building class.  This is a somewhat misleading indicator.  Why?  Because it does not reflect the rent after negotiations, which often includes reductions in rate from the Asking Rate and potentially significant landlord-funded concessions.  In other words, Asking Rents reflect what landlords are asking, not what they’re getting.

Even if market reports cited the actual rental rates tenants have contracted to pay in leases (“Face Rates”) they wouldn’t accurately reflect the true value of the space in the market. These values are only reflected in “Net Effective Rates”, rates derived after deducting the value of landlord-funded concessions from the Face Rent.  Net Effective Rate is a much better proxy for market value.

Why so much complexity?  It’s because a key chapter in the modern landlord playbook calls for the financial engineering of higher Face Rates.   This is because assets are valued by capitalizing net operating income (“NOI”) which is a byproduct of Face Rate.  The higher the Face Rate, the higher the NOI, the higher the value. 

Here’s an example of how this might play out in a proper market-based negotiation.  Tenant tours a space with broker and decides to include it on a short list of sites with which to negotiate.  Landlord’s initial proposal indicates a $70/sf starting rent with 3% annual increases over a lease term of 8-years, with 3 months of free rent and $50/sf in landlord-funded tenant improvements.  The Average Net Effective Rent (before deducting operating expenses and taxes) for the proposed transaction is $69.41/sf (assuming a straight-line amortization of the $50/sf tenant improvement allowance).  This, despite an average Face Rent of $77.81. 

In other words, there is already an $8.40/sf gap between the Average Face Rate and the Average Net Effective Rate associated with the landlord’s initial offer.  Now, let’s say the market value of the space is an Average Net Effective Rent of $55/sf.  The question becomes how can the tenant get full market value while the landlord still preserves its minimum Face Rent requirement?  The answer lies in the concessions.   For sake of this example, imagine the landlord must preserve a Face Rate of $65/sf.  To meet the market value and secure the tenancy, the landlord must enhance the concessions.  To do so, it might double the amount of the tenant improvement allowance from $50/sf to $100/sf, drop the Face Rate to $65/sf, and increase the free rent from 3 months to 7.  This yields an Average Net Effective Rate of $55/sf, in line with market.

Data is everywhere today.  But do you have the right data, and/or, do you know what to do with it?  The role of a great tenant advisor it to help identify the right data, correctly interpret its meaning, and use it to develop a strategy that ensures its tenant client achieves maximum market value.