The comments that follow refer to "Face Rent" and "Effective Rent" in the context that they are market oriented. They are intended to raise issues and promote discussion.

"Face Rents" may not be new, however the concept took hold in the early 1990's with the property downturn that followed the property boom of the late 1980's. "Face Rents" are a predominant factor in inner city office markets however have extended across a number of market sectors.

"Face Rent" is the term given to rent payable by a tenant prior to adjustment for incentives provided by the landlord as part of the total agreement. The "Effective Rent" is the rental after adjustment for such incentives.

For example: A landlord might be prepared to offer a 12 month rent free period (incentive) to a tenant prepared to sign a five year lease at a rental of $250 per square metre per annum commencing in the second year (ie: following the rent free period). The "Face Rent" in this example is $250 per square metre per annum where as the "Effective Rent", in simple maths, is $200 per square metre per annum.

We at Herron Todd White Brisbane Commercial believe "Face Rents" took hold in the early 1990's because people in the property industry were able to be convinced that the incentives offered to attract tenants to an oversupply of office accommodation were a short term fix that would right itself when the oversupply was absorbed and "Effective Rents" returned to their rightful level. While there was a certain amount of logic to this "Face Rents" remain the norm for office buildings in Brisbane's central business district in 2002 and are causing some confusion in the market. Market norms returned more to "Effective Rents" in Sydney and Melbourne in late 1990's, however incentives and "Face Rents" are becoming more regular again.

While those experienced in the industry are able to deal with the "Face Rent" concept when assessing the value or worth of a property, we at Herron Todd White Brisbane Commercial believe the concept has no real worth in the marketplace and only adds to the confusion of those less experienced. This confusion causes more issues in the fringe markets, where there is less consistency in approach and less general knowledge of the incentives provided from building to building.

"Face Rents" are commonly dealt with by using a cashflow model where the investor/valuer can make provision for existing incentives on the actual basis they were provided (if disclosed) and provide for further incentives asleases roll over. Others simply apply higher returns where "Face Rents" are capitalised, however this method becomes more complex where incentives take a variety of different forms (cash back / fitout / monthly rebates etc.) and are at different stages for different tenants.

We at Herron Todd White Brisbane Commercial believe the appropriate methods are:

• the cashflow model, which deals with actual income streams and makes provision for new incentives at the roll over of leases, or
• capitalisation of "Effective Rentals" plus the present value of above market rentals that resulted from up-front incentives.  This capitalises the true underlying rental income ("Effective Rental" in perpetuity, rather than the false "Face Rental" income.

The only logic to suggest that the capitalisation of "Face Rents" is appropriate, is that this approach more accurately reflects the approach taken by purchasers. We at Herron Todd White Brisbane Commercial believe valuers have a role as experts, and hopefully as leaders in the property industry to adopt a correct approach which clearly demonstrates how a property's value is made up.

Even though the capitalisation of "Face Rents" should provide the same answer as the capitalisation of "Effective Rents", the capitalisation of "Effective Rents" and making the appropriate adjustments provides a user of the advice a clearer picture of how the property's value is made up and the impacts this will have for an investor in that property.

Herron Todd White Brisbane has developed a tool for comparing "Face Rents" and "Effective Rents".  Whether you are a tenant or a landlord you should understand the impact of incentives on you cashflow.  To do so Contact HTW's Brisbane Commercial Office .  Example of tool to compare "Face" and "Effective" Rents.  

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