Effective rent is a common real estate term, though its exact meaning varies with context. The concept of effective rent has significant implications for renters, landlords and accounting professionals.
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Effective Rent for Renters
The most common usage of the term effective rent is in apartment for rent ads. You'll often see the phrase effective rent or net effective rent in apartment listings. The net effective rent is typically less than the actual rent, so landlords use this term in apartment ads to make the rent seem lower. Potential renters may find themselves paying hundreds of dollars more per month before concessions. The textbook definition of effective rent for renters is the actual rental rate after deducting concession values from base rental.
Effective Rent for Landlords
While the term effective rent is often used to lure potential renters, the calculation itself applies more to landlords. When landlords offer concessions that have cash value, such as one month rent-free or amenities that cost the landlord money, the landlord is losing money from actual rent. When determining an actual rent rate and whether a deal is profitable, landlords must calculate the cost of concessions, maintenance and renovations to determine effective rent.
Calculating Effective Rent
For renters, monthly effective rent is an easy calculation: The annual cost of rent minus concessions divided by the number of months in the least, which is usually 12. So if an apartment is $24,000 to rent annually, and you get one month of free rent which adds to $2,000, your effective monthly rent would be $1,833. Landlords must add costs such as renovations, operating expenses, taxes, insurance and other costs associated with the property to determine the effective rent from the landlord's perspective.
Accounting vs. Real Estate
Accounting uses a slightly different definition of effective rent than real estate applications. In accounting, to determine the effective rent you calculate the average rent over the rental term, exclude escalations and include rent abatement and free rent. In accounting, rent abatement affects the cash flow analysis and profit and loss statement. In real estate, by contrast, effective rent is the total rent, including escalations, divided by the number of months in the term and multiplied by 12 to calculate the monthly effective rent.