Concessions and free rent
Also called Concessions, Free rent, Rent abatement.
A concession is rent given away to sign or renew a lease, most often as free months at the start of the term. It is a deduction on the way from gross potential rent to effective gross income, and it is what separates the asking rent on a rent roll from the rent a tenant actually pays.
How it works
Concessions matter more than their dollar size because they are invisible in the number everybody quotes. A unit advertised at $2,090 with one month free on a twelve-month lease collects $22,990 over the year, which is $1,916 a month. The rent roll shows $2,090, the market survey shows $2,090, and the $174 a month difference appears only in the collections line of the operating statement.
Two ways of stating rent are both in use and they are not interchangeable. Net effective rent spreads the abatement across the term and reports what the tenant will average. Face rent is the contract rate with the free months disclosed separately. Commercial leases almost always quote face rent, because the face rate sets the escalations and the recovery base and is what a future buyer capitalizes, so the abatement has to be modeled as its own cash flow rather than folded into the rate.
For underwriting the question is whether the concession is a lease-up cost that burns off or a standing feature of the submarket. A property finishing its lease-up should stop paying for occupancy it already has. A submarket absorbing three more years of deliveries will keep paying, and in that case the concession is not a discount off market rent, it is market rent.
Formula
Net effective rent = face rent x (months paid / total months in the term)- Months paid is the term less the abated months
- One month free on a twelve-month lease is an 8.3 percent discount; two months is 16.7 percent
- Concessions given to renew are as real as concessions given to sign, and are more often left out of a model
Worked example
220 units, asking rent $2,090 a month. A lease-up offer of one month free on a twelve-month lease, taken by 66 units during the year.
| Asking rent, annualized per unit2,090 x 12 | $25,080 |
|---|---|
| One month abated | ($2,090) |
| Rent collected per unit over the term | $22,990 |
| Net effective rent per month | $1,915.83 |
| Concessions across the 66 units that took one | ($137,940) |
| Net effective rent as a share of asking | 91.7% |
The rent roll reports $2,090 on every one of those units. If the concession is a standing feature of the submarket rather than a lease-up cost, the $137,940 is a recurring deduction, and at a 5.40 percent cap rate it is worth about $2,554,000 of value.
Conventions worth knowing
- Ask what is being offered on new leases this week, not what was offered across the trailing year. Concessions move faster than any other revenue assumption.
- Renewal concessions are frequently undocumented. A property offering a month free to renew has a concession the rent roll will never show.
The common mistake
Underwriting the burn-off without underwriting the reason
A pro forma that removes concessions in year one is making a market call, not a modeling choice: it says the property will lease at face rent when it cannot today. Sometimes that is right, because the concession existed to fill a lease-up and the lease-up is finished. Sometimes the submarket has new supply delivering for three more years and the concession is permanent. Before assuming burn-off, check what the competing properties are offering now, and if the concession stays, take it out of the market rent assumption rather than carrying a face rent nobody pays.
Related terms
- Effective gross incomeEffective gross income is all the revenue a property is expected to collect in a year: gross potential rent, less vacancy, loss to lease, concessions and bad debt, plus other income. It is the revenue figure operating expenses are subtracted from to reach net operating income.
- Gross potential rentGross potential rent is the rent a property would collect if every unit were occupied for all twelve months at full rent, with no vacancy, no concessions and no delinquency. It is the top line of the pro forma, and everything below it is a deduction.
- Loss to leaseLoss to lease is the difference between what a unit could rent for at today's market rate and what the sitting tenant is contractually paying. It appears as a deduction from gross potential rent when the pro forma is stated at market rent.
- Economic versus physical occupancyPhysical occupancy is the share of units that are occupied. Economic occupancy is the share of potential rent that is actually collected. The gap between them is everything that stops an occupied unit from paying full rent: loss to lease, concessions, bad debt, employee units and down units.
- Bad debt and credit lossBad debt is contracted rent that was billed and never collected. It is deducted alongside vacancy on the way to effective gross income, and unlike vacancy it does not resolve when the unit is leased, because the unit is already leased.
- Renovation budgetA renovation budget is the funded capital a value-add plan spends to lift rents: the scope and cost per unit, the pace at which units can be delivered, and the rent premium the finished unit is expected to earn. It belongs in the sources and uses at closing, not in operating expenses.
Keep reading
Every figure, traced to its source
Altyst computes these in exact decimal arithmetic, not with a language model, and clicking any number shows the formula behind it.