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| Effective Age |
| The estimated age in years as indicated
by the condition and utility of a structure
based on the age of structures of equivalent
utility, condition, and remaining life
expectancy, as distinct from chronological
age. |
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| If a building has had better than
average maintenance, its effective age may
be less than its actual age. If there has
been inadequate maintenance, it may be
greater. A 40-year-old building may have an
effective age of 20 years due to
rehabilitation or modernization. The
effective age is an important consideration
in appraisal as it affects the amount of
depreciation deducted when estimating value
by the cost approach. |
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| Effective Date |
| The day or date upon which something
occurs or ceases to occur. |
| |
| The effective date of an appraisal is a
good example from a real estate perspective.
While the estimate of value is indicated to
apply as of a specific date, the work done
in arriving at the estimate may have been
completed days, months, or even years after
the effective date indicated in the
appraisal. |
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|
Effective Gross Income |
| The estimated potential gross income
from all sources after allowance to cover
losses due to vacancies and bad debt. |
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| Effective gross income is frequently
used by appraisers when applying the income
approach in an appraisal. The appraiser must
reconstruct the operating statement of the
income property to arrive at a net annual
operating income that is then capitalized to
arrive at value. For example, individuals
involved with real estate investment
analysis frequently use the term gross
operating income as opposed to effective
gross income. |
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|
Effective Interest Rate |
| The true rate of interest charged on a
loan. |
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| The stated or nominal interest rate is
most commonly discussed in the marketplace
and normally refers to the interest rate
charged on a loan without consideration for
any compounding that occurs during the time
period. If no compounding takes place, the
stated (or actual) and effective rates would
be the same. The effective rate takes into
consideration the impact of compounding and
consequently produces a higher, true rate of
interest. |
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| Effective rates are particularly
important in relation to mortgages. For real
estate practitioners, most discussions with
consumers concerning mortgages centre on the
nominal or stated rate. As with all loans in
which compounding occurs, the effective rate
is higher than the stated rate. However, the
Interest Act sets out specific requirements
concerning how the effective rate is
calculated on mortgages involving blended
monthly payments. The federal statute
dictates that if a mortgage has blended
principal and interest payments, the
interest must be calculated annually or
semi-annually, not in advance. The net
effect of this requirement is to reduce the
effective rate through no more than two
compounding periods per year and such
compounding cannot be calculated in advance. |
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| Without delving into the complexities of
calculating semi-annual not in advance
payments, a simple example using a personal
loan will illustrate the difference between
nominal and effective rates. If an amount is
compounded on an annual basis, the nominal
and effective rates are the same. However,
when compounding occurs more frequently, the
effective rate rises above the nominal. In
the example, the difference is 0.25%. |
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|
Effective
Rent |
| Most commonly used with commercial
leasing and the comparison of true costs
associated with different leased premises.
As a generally accepted definition,
effective rent (based on the tenant’s
perspective), includes the contracted base
rent plus all additional costs, less any
concessions and allowances. Effective rent
is typically calculated based on the annual,
as opposed to the monthly rent. Effective
rent can also be expressed as a rate, e.g.,
annual rate per square foot. The calculation
of either effective rent or rate is most
commonly associated with tenant cash flows.
However, effective rental calculations can
also be developed from the landlord’s
perspective. |
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| Effective rents can also be calculated
from either before tax or after tax
perspectives. The effective rate is usually
calculated based on rentable area as opposed
to useable area, but advanced packages
provide comparisons using both approaches. |
| |
| When representing tenants, commercial
practitioners develop detailed cash flow
estimates and effective rents for selected
properties to generate accurate comparisons
involving various offerings. Understandably,
given the wide variety of lease
arrangements, each calculation of effective
rent has its own distinct considerations.
Historically, effective rent simply referred
to rental amounts (contracted base rent plus
all additional rents less any concessions
and allowances). Detailed comparisons are
now possible given the proliferation of
software packages, advanced financial
calculations, and the ability to manipulate
variables and develop alternate scenarios.
The following items are considered when
developing effective rents. |
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| Tenant Costs:
Tenant costs include all tenant-paid
improvements, moving costs, buy out from a
previous lease, and operating costs
including provisions for escalations based
on the CPI or other formulae. Normally,
out-of-pocket expenses by the tenant that
would apply to any new location would not be
included in the calculation, but no rigid
rule exists regarding this issue. |
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| Landlord Costs:
Concessions and allowances by the landlord
are included, e.g., free rent, improvement
allowances, moving allowances, and any other
concessions provided to the tenant.
Concessions and allowances can either be
shown in the calculations or netted against
tenant costs. |
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| Cash Flow Before Tax:
Detailed cash flow estimates are typically
included. The sum of contracted rent, plus
all tenant costs, less landlord costs
produces a cash flow analysis (before tax
occupancy cost), for successive years in the
lease term. |
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| Total and Annual Effective Rents |
| Both annual and total effective rents
are usually provided. The total effective
rent refers to the sum of all expenditures
over the lease period, while the annual
effective rent involves expenditures for one
specific year. |
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| Discounted Effective Rents |
| Effective rents can be discounted based
on a market-extracted discount rate.
Advanced programs include this ability as it
ensures accurate comparisons of various
leasing arrangements by accounting for the
timing of cash flows throughout the lease
term. The calculation typically acknowledges
the timing of lease payments including the
allocation of various costs and
concessions/allowances depending on the
particular year and month in which they
occur. When calculating the discounted
effective rent, most costs are typically
entered on a cash accounting basis with no
consideration for the amortization of such
costs. In selected instances, tenant
improvements may be amortized over the lease
period. |
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| Caution |
| Effective rent for the tenant (user)
will often vary from effective rent for the
landlord (investor). For example, various
costs identified may not be paid to the
landlord, but relate solely to the tenant,
e.g., moving expenses in the relocation
process. In this instance, the effective
rent for the tenant would be higher than the
effective rent for the landlord (assuming
the landlord had no offsetting concession or
allowance). Practitioners must clearly
identify whether the tenant’s or landlord’s
perspective is being examined, as well as
detailing relevant factors under
consideration. Generally, most references to
effective rent relate to the user (tenant)
and not the investor (landlord) unless
otherwise noted. |
