What does net effective rent actually mean and what do I end up paying?

Originally posted on August 20, 2018 2:21 pm
Updated on June 30, 2021 4:06 pm

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When you are searching for a new apartment to rent, there are lots of things you will consider before signing on the dotted line. Location, proximity to amenities, how old the building is, and many more factors all go into helping us decide whether to rent an apartment or keep searching for another. For some people, the search is relatively quick, but for others, it can be much longer.

However, the most important thing for most of us is the price of the rent in the apartment. Price will often vary greatly from one neighborhood to another and even one apartment to another. Thankfully, most ads for an apartment will include the price, which can make it quick and easy to filter out options that are out of your range.

However, the price that is advertised might not be as clear as it seems. This is due to the fact that some landlords and agents will use gross rent and some will use net effective rent when deciding which price to post on the ad. Depending on which is used, you could actually end up paying a vastly different amount than you were expecting. And once you sign the contract, getting out of it isn’t always easy, so be sure to know the difference between gross rent and net effective rent, and what they both actually mean. You will benefit a lot in the long run if you are aware of the difference between the two. Now, neither is better or worse, but it is important to know the difference.

Gross rent is quite simple to understand and explain. The gross rent is the combined amount of all the monthly payments. So if you pay $1200 a month, your gross rent would be $14,400. While this isn’t always the case, gross rent might include other costs such as utilities. So if the landlord lists “gross rent” on the advertisement, it is quite simple to know what they are saying.

However, net effective rent can be a little bit more confusing to understand. See, many landlords will offer some kind of a promotion when trying to attract new tenants into one of their units. This is commonly in the form of one free month’s rent. Now, some landlords will just give you the last or second last month free, while others will simply spread out the discount over the entire year.

So essentially, net effective rent refers to the total amount a tenant will pay, including the promotion. So if your gross rent is $14,400 ($1200 a month), but there is a one month free promotion, your net effective rent would actually only be $13,200 ($1100 a month). It is very straightforward to understand, but can involve a bit of math if the landlord or advertisement doesn’t provide you with much information. Basically, you take the total amount of the promotion/concession, divide that by the term of the lease, and then subtract that amount from the monthly rent.

So as you can see, the gross rent on an apartment will almost always be higher than the net effective rent, as it doesn’t take into account any special deals or promotions. However, even if the advertisement shows net effective rent, it is a good idea to do some calculations to figure out the gross rent as well, so you know what you will likely be paying if you decide to renew, as most promotions will only exist for your first year.

Also, when you renew, you will be negotiating based on the gross rent, not the net effective rent, as that included a promotion or discount. Of course, depending on your landlord and their policies, or how good of a tenant you have been, the company might be willing to wiggle a little bit on price and maybe give you a small discount, but don’t expect to get the  “free month” that you had before.

Reading the lease closely is always incredibly important, but that goes double when dealing with net effective rent. This is because the lease is what will tell you how the discount is applied, what your gross rent would be without the discount and more. If you are ever curious about the terms or pricing of your apartment (or any other information), the lease agreement is the place to look.

In conclusion, it is a very good idea to familiarize yourself with the difference between gross rent and net effective rent, as it will benefit you a lot throughout your tenancy. If you are not aware of the difference, paying for rent at the end of the month and renewing at the end of your term could be a little bit confusing.

Important Gross vs Net Price Differences

The net effective rent is the best metric for determining your monthly rent, but only if you stay for exactly the duration of your lease.  If you renew or extend your lease at the gross rent amount, then your net effective rent gradually increases because you are spreading the promotional discount over a longer time period.  Unfortunately, to get the best deal during a renters’ market, one often needs to be very flexible.  You might need to move every 12 months, as landlords are reluctant to offer similar deals to renewing tenants (why not?  because they are calling the bluff – most tenants hate moving!)

Take a look at the actual broker blast above from luxury highrise landlord UDR, advertising a studio apartment at 805 Columbus Avenue. On the showcased datasheet, we see unit 5D advertised with a net effective rent of $3106. In the description, we see them explain that the quote is the net effective rent. The gross rent is $3549.38 with 1.5 months free. How exactly is the gross rent and net effective rent calculated?

To start the analysis, realize that MOST, but not all, net effective rents are calculated on a 12-month pre-promotional duration. To get the post-promotional duration of the lease, you take the pre-promotional duration and add the number of free months. For those familiar with venture financing deals, it is similar to the way investors quote pre and post money valuations.

Here is the problem – not all broker blasts are clear on the required durations, but will quote the gross, net effective, and number of months free. That leaves the real estate broker or consumer to actually deduce the computation. For our example, imagine in our example, we guess the post-promotional duration is 13.5 months, (12 months + 1.5 months free).

Next, the net effective multiplied by the post-promotional duration should equal the gross rent times the pre-promotional duration. In our example, $3106 is the net effective rent. What is $3106 times 13.5? It is $41,931 over a 13.5-month lease. Quite a chunk of change!

How about the gross rent? It should be the amount you pay for the lease, but divided by the pre-promotional duration. So here, it is 41931 divided by 12, which equals $3,494.25. Uh oh, that doesn’t quite work. It seems the landlord is being a little less generous than we thought (same net effective, but rent will rise sooner and with a larger jump).

Pre-Promotional and Post-Promotional Duration

As we saw in the UDR example above, the net effective was quoted at $3106, the gross quoted at $3549.38, and the number of months free at 1.5 months. We saw that assuming the most common case of 12 pre-promo months was incorrect, as the numbers did not check out.

The second most common way of quoting is using a 12 month post-promotional duration. That means the pre-promo duration is 10.5 months, leading us to the following equiation.

$3106 * 12 = $37,272

Now to get the gross rent, we divide $37,272 by 10.5 months (pre-promo).

$37,272 / 10.5 = $3549.71

Indeed, this time the numbers check out, and it means you only enjoy the net effective for 12 months before facing a potentially sharp rise to the gross rent at the one-year mark.

Knowing this math also reveals the landlord was rounding just a little bit. The actual gross they quote is $3549.38, a rather strange number. Once you know the pre and post-promotional durations, it is very easy to convert between gross and net effective. Here it is:

Gross Rent * (Pre-Promo Duration / Post-Promo Duration) = Net Effective

$3549.38 * (10.5 / 12.0) = $3105.7075

Turns out they rounded slightly to $3106 net effective. Should you ask for the 29 cents back per month?

Bottom Line: Know How To Compute Gross vs Net Price, and Pre/Post Duration

The main takeaway is to familiarize yourself with how rents are quoted. Not only will the math help you reduce a lot of confusion, you will also know when you will need to make a crucial decision – move again or brace for a heated renewal negotiation.

Pre-promo Duration + Number Months Free = Post-promo Duration

Gross Rent * Pre-Promo Duration = Net Effective * Post-promo Duration

The most common Pre-Promo Duration is 12 months. If a listing advertises net effective with 1 month free, you can compute the gross by multiplying the net effective by 13 / 12, and you can expect to make a renewal decision in 13 months.

However, this is not always the case! If you aren’t sure, ask the landlord or your real estate agent. At RentHop, most listings quote the net effective price. We find it is the best way to compare various apartment options when searching for your next home. However, some landlords insist on only posting the gross rents; if you are not sure, be sure to double-check!

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