Effective rent accounts for concessions by:
Correct Answer
D) Spreading their cost across the lease term
Why this is correct: Effective rent accounts for concessions (like free months) by amortizing the value of the concession over the lease term. For example, two free months on a 24-month lease reduces the annual effective rent by spreading the 'cost' of those free months across the entire lease. Why the other choices are wrong: 'Deducting them from the reversion' incorrectly applies concessions to the property's future sale value. 'Adding the concession value to the face rent as income' would inflate income, not reflect the true lower rent actually paid. 'Ignoring them as a marketing expense' would misstate the actual income stream a property generates. Exam tip: To compare leases with different concessions, always calculate and use the effective rent.
Why This Is the Correct Answer
Spreading the concession over the lease term converts a face rate into what the landlord actually realizes per period, which is the only basis on which leases with different inducements can be compared. It handles free rent, allowances, and other inducements the same way, by charging their cost against the income stream they bought. The result feeds a more honest market rent conclusion and a defensible income approach. Choice D describes the mechanism precisely.
Why the Other Options Are Wrong
Option A: Deducting them from the reversion
The reversion is the property's value at the end of the holding period, derived by capitalizing income after the projection ends, and it is a resale concept rather than a rent concept. Concessions affect what the landlord collects during the term, which is the income side of the model. Charging them against the reversion would misplace the cost in both amount and timing.
Option B: Adding the concession value to the face rent as income
Adding the concession to face rent moves the number in the wrong direction, since a concession is a cost to the landlord and a benefit to the tenant. Doing so would report income above even the stated face rate and would inflate value on capitalization. The option inverts the sign of the adjustment.
Option C: Ignoring them as a marketing expense
Treating concessions as a marketing expense hides them on the expense side while leaving an overstated rent on the income side, which distorts both lines and makes the lease look stronger than it is. It also breaks comparability, because a competing lease with no concession and a lower face rent would appear inferior when it may be superior. Concessions are part of the rental bargain, not an incidental cost of doing business.
Spread the Freebie
Two months free on a two year lease is not free; it is a discount paid in one lump and earned back over 24 months. Spread the freebie across the term and the real rent appears.
How to use: When a stem mentions free rent or allowances, divide the total consideration by the number of periods before comparing leases. Any option that ignores, adds, or relocates the concession is wrong.
Exam Tip
Watch for questions that give a face rent and a concession and ask for market rent. The exam wants the effective figure, so do the spreading before you compare.
Common Mistakes to Avoid
- -Using face rent from lease comparables without adjusting for concessions
- -Averaging concessions over the wrong period, such as one year instead of the full term
- -Double counting a tenant improvement allowance as both a rent reduction and a capital cost
Concept Deep Dive
Analysis
Face rent is the number printed in the lease, and in soft markets it is frequently propped up by inducements that never appear in that number: free rent periods, above-standard tenant improvement allowances, moving allowances, and buyouts of a tenant's prior obligations. Landlords prefer this structure because a high face rent supports the building's apparent income and its value, while the concession is a one-time cost buried in the deal. Effective rent restates the economics by spreading the concession's cost across the lease term, so a lease at $24 per square foot with two months free on a 24 month term is really about $22 per square foot to the landlord. Appraisers need effective rent to compare leases signed on different terms, to estimate market rent honestly, and to avoid capitalizing income the landlord never actually collects. In a discounted cash flow the better practice is to model the free period and the allowances explicitly in the year they occur, but for direct comparison of lease comparables the averaged effective rent is the standard tool.
Background Knowledge
You need the difference between face or contract rent, effective rent, and market rent, and the common concession types including free rent, tenant improvement allowances, and moving allowances. You should also know how effective rent is computed by averaging the total consideration over the term, sometimes on a present value basis, and when a discounted cash flow model should instead handle concessions explicitly in the periods they occur.
Real-World Application
An appraiser comparing four office leases finds face rents from $23 to $27 per square foot, computes effective rents after three to six months of free rent and varying improvement allowances, and finds the range collapses to $21 to $22, which becomes the supported market rent conclusion.
More Income Approach Questions
In a percentage lease, rent is commonly structured as:
In a DCF, what is the reversion?
Potential gross income differs from effective gross income in that PGI assumes:
The reversion in a discounted cash flow model represents:
Building A (new, credit tenant, 20-year lease) and Building B (older, month-to-month tenants) sell the same week. Their cap rates should differ how?
An overall rate extracted from a sale whose NOI excluded reserves, applied to a subject NOI that includes them, will:
Replacement reserves cover which kind of expenditure?
What is the primary distinction, for appraisal purposes, between 'vacancy loss' and 'collection loss'?
An appraiser is analyzing a mixed-use property with retail and office components. The retail segment has a potential gross income of $180,000 with a market vacancy of 8%. The office segment has a potential gross income of $120,000 with a market vacancy of 12%. What is the overall effective gross income for the property?
The mortgage constant represents:
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