What is the difference between face rent and effective rent?

Face rent, or headline rent, is the figure written in the lease. Effective rent is what the landlord really receives once the incentives given to win the tenant are spread over the term: rent-free periods, fit-out contributions, cash payments. A ten-year lease at a face rent of US$800,000 with US$2.0m of incentives has an effective rent of US$600,000 a year on a simple calculation. The face rent sets reviews and appears in valuers' evidence; the effective rent shows what the space earns.

How do you calculate net effective rent?

Start from the rent the lease names for the whole term, take off the value of the rent-free months, the fit-out contribution and any cash paid to the tenant, and average what is left over the years of the lease. That simple figure ignores timing. The careful version discounts each payment and each incentive to today and finds the level annual rent with the same present value, which is lower when the incentives are paid early. In Australia and New Zealand, 'net' often also means the rent is quoted before outgoings, which the tenant pays separately; a reader should check which sense is meant.

Why do landlords offer incentives instead of lower rent?

Because a higher face rent supports the building's value, sets a higher base for later rent reviews and becomes evidence for other lettings. A landlord with a loan may also prefer a higher face rent because its lender's covenants or valuation rest on it. The cost is that the incentive is paid in cash or forgone rent, often at the start of the lease, and a reader who sees only the face rent overstates what the building earns.

How are rent-free periods treated in a landlord's accounts?

Under IFRS 16 and its Australian and New Zealand versions, the landlord counts lease payments net of incentives and, for an operating lease, recognises the income on a straight-line or other systematic basis across the lease, so rent appears in the income statement during a rent-free period. The UK's FRS 102 also spreads a lessor's incentives over the lease term. The reported rental income is therefore closer to effective rent than to the cash received in the early years.

// WORKED EXAMPLETHE ARITHMETIC A DECISION RESTS ON

Effective Rent: a Worked Example

The lease says one rent. The landlord's bank account says another.

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED 2026-11-07 · 6 MIN READ

// THE SHORT ANSWER

A lender meets effective rent when a newly let building's rents look strong and its owner's bank account does not. It is the rent a letting really earns once what the landlord gave to win the tenant, free months, a fit-out contribution, a cash sum, is charged against the rent the lease names, taken as an average over the term. The lender reads it for two reasons. It is the better guide to what the space would let for next time, and the incentive behind it is cash the landlord gives up or pays out while interest on the loan is still due.

BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.

// MAKE THE CALL

Issue 08 — Basalt Ridge Developments. A new-to-bank developer, a claimed 28% ROE and two other banks circling. Your bank has a growth target. Your call first, then the senior banker's.

Read the file →

PART OF Property Development Finance

// 01 — WHY THE FACE RENT IS NOT THE RENT

Landlords often prefer to give a tenant something other than a lower rent. A higher figure in the lease supports the building's value, sets the base for future reviews and becomes evidence for the next letting nearby. So when the market is soft, a landlord may hold the face rent and pay for the letting in other ways: rent-free months at the start, a contribution to the tenant's fit-out, a cash payment, or taking over the rent on the tenant's old premises.

Each is a real cost and each is out of sight in the rent line. A building can show a rent roll at last year's rents while its owner has been paying a quarter of them back to win the tenants. The lender needs the rent the space earns net of what it cost to let, because that is what the next letting is likely to achieve and what the property's income will be once the incentive is gone.

// 02 — HOW EFFECTIVE RENT IS CALCULATED

Simple: (face rent over the term − cost of incentives) ÷ years of the term

Discounted: the level annual rent with the same present value as

the face rent received, less the incentives paid

Incentive %: cost of incentives ÷ face rent over the term

The simple method ignores when the money moves, and is the one most often quoted. The discounted method recognises that a fit-out contribution paid on day one costs more than the same sum of rent forgone in year ten, and, when the incentives come early in the lease, gives a lower effective rent. Some calculations also load in the landlord's agent's fees. In Australia and New Zealand, office incentives are often quoted as a percentage of the face rent over the term; in the UK, often as months rent-free. Either way, the reader should ask which method produced the figure.

The accounts spread the incentive too. Under IFRS 16 and its Australian and New Zealand equivalents, a landlord's lease payments are counted net of incentives and an operating lease's income is recognised on a straight-line or other systematic basis; the UK's FRS 102 also spreads a lessor's incentives over the lease term. A landlord's income statement can therefore show rent in a year in which it received none. A contribution that pays for works the landlord itself owns is usually capitalised as part of the building instead.

// 03 — THE EXAMPLE

An office building in a regional city, constructed for this page like every figure in it, lets two empty floors to a professional services firm on a ten-year lease. The face rent is US$800,000 a year. To win the firm, the landlord gives twelve months rent-free and pays US$1.2m towards the fit-out on day one. The discount rate is the example's, and rent is treated as paid at each year-end.

Face rent over the term: 800,000 × 10 = 8,000,000

Rent-free year: − 800,000

Fit-out contribution: − 1,200,000

Net rent over the term = 6,000,000

Effective rent, simple: 6,000,000 ÷ 10 = 600,000 a year

Incentive: 2,000,000 ÷ 8,000,000 = 25% of face rent

Discounted at 7%:

face rent, years 2–10: 800,000 × 6.089 = 4,871,000

less fit-out on day one − 1,200,000

present value = 3,671,000

level rent with that value: 3,671,000 ÷ 7.024 = 523,000 a year

The lease says US$800,000. The space earns US$600,000 on the simple reading and about US$523,000 once the timing is counted. Now put the floors in the building. The other floors pay US$1.0m, and the owner has a loan of US$14m at 6.5%:

Interest: 14,000,000 × 6.5% = 910,000

Cover on face rent: 1,800,000 ÷ 910,000 = 1.98×

Cover on year-one cash rent: 1,000,000 ÷ 910,000 = 1.10×

Landlord's reported rental income, year one (straight-line):

1,000,000 + 600,000 = 1,600,000

In year one the accounts report US$1.6m of rent, the lease schedule shows US$1.8m, and the bank account receives US$1.0m, with US$1.2m paid out for the fit-out besides. Three numbers for one building, and only the last pays the interest.

// 04 — HOW IT DIFFERS FROM MARKET RENT

Market rent is a valuer's opinion of what the space would let for today; effective rent is a fact about one lease. The two meet in the evidence. A valuer reading recent lettings at face rents can conclude that rents have held when the incentives say they have fallen, and a review to market based on face-rent evidence can lift a tenant's rent above what the space earns. A tenant paying a face rent held up by incentives may be paying above what a new tenant would pay with no incentive, and the building is then partly over-rented.

DEFINED IN ONE PARAGRAPH → · OVER-RENTED PROPERTY, WORKED → · NET OPERATING INCOME →

// 05 — WHERE IT DECIDES A FILE

A lender's first question on a recently let building is what each letting cost. The answer changes three things. The income it lends against, which should be the cash the property will receive over the loan, not the rent in the leases. The interest cover in the rent-free months, which a lender may meet with an interest reserve, a guarantee or a smaller loan until the free period ends. And the valuation, which should rest on effective evidence and deduct any incentive still owed, such as a fit-out contribution not yet paid.

The incentive also returns at expiry. If the next tenant expects the same package, the vacancy allowance on that lease should include it, and a weighted average lease expiry that looks long can hide a large incentive bill at the first big expiry.

THE RENT ROLL, READ → · VACANCY ALLOWANCE, WORKED → · INTEREST COVER →

// SOURCES

The documents the statements on this page rest on. Each was opened and checked when cited.

Australian Accounting Standards Board, AASB 16 Leases (compiled to 31 December 2023), the Australian text of IFRS 16 — paragraph 81 and Appendix A ('lease payments', 'lease incentives') — Requires a lessor to recognise operating lease payments as income on a straight-line or other systematic basis, and defines lease payments as fixed payments less any lease incentives — section 02.
HMRC, Business Leasing Manual BLM12025 — lessor accounting for lease incentives — Sets out FRS 102 paragraph 20.25A (lessor spreads the aggregate cost of incentives over the lease term) and says the same applies to lessors under the 2024 amendments and IFRS 16 — section 02.

// QUESTIONS PEOPLE ASK

What is the difference between face rent and effective rent?: Face rent, or headline rent, is the figure written in the lease. Effective rent is what the landlord really receives once the incentives given to win the tenant are spread over the term: rent-free periods, fit-out contributions, cash payments. A ten-year lease at a face rent of US$800,000 with US$2.0m of incentives has an effective rent of US$600,000 a year on a simple calculation. The face rent sets reviews and appears in valuers' evidence; the effective rent shows what the space earns.
How do you calculate net effective rent?: Start from the rent the lease names for the whole term, take off the value of the rent-free months, the fit-out contribution and any cash paid to the tenant, and average what is left over the years of the lease. That simple figure ignores timing. The careful version discounts each payment and each incentive to today and finds the level annual rent with the same present value, which is lower when the incentives are paid early. In Australia and New Zealand, 'net' often also means the rent is quoted before outgoings, which the tenant pays separately; a reader should check which sense is meant.
Why do landlords offer incentives instead of lower rent?: Because a higher face rent supports the building's value, sets a higher base for later rent reviews and becomes evidence for other lettings. A landlord with a loan may also prefer a higher face rent because its lender's covenants or valuation rest on it. The cost is that the incentive is paid in cash or forgone rent, often at the start of the lease, and a reader who sees only the face rent overstates what the building earns.
How are rent-free periods treated in a landlord's accounts?: Under IFRS 16 and its Australian and New Zealand versions, the landlord counts lease payments net of incentives and, for an operating lease, recognises the income on a straight-line or other systematic basis across the lease, so rent appears in the income statement during a rent-free period. The UK's FRS 102 also spreads a lessor's incentives over the lease term. The reported rental income is therefore closer to effective rent than to the cash received in the early years.

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// ON WHOSE DESK

The seats that read this term in an ordinary week. Each page says what the seat is for, who arrives in it, and the shape of the round it runs.

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SIGNAL OR NOISE · THE ECONOMY · COLLATERAL MARKETS

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3 MORE ON THE ECONOMY · COLLATERAL MARKETS →WHERE DO YOU READ FROM? THE PLACEMENT →

THE READING ROOMIN ONE PARAGRAPHEffective rent (lease incentives) What is effective rent, and how do lease incentives hide behind face rent?