Contract Rent
Sometimes referred to as In-Place Rent, Contract Rent is the rent being charged/collected on existing leases at a property. In contrast to Market Rent, contract rent is not based on market conditions but rather is based on the lease contract signed between the landlord and tenant.
Putting ‘Contract Rent’ in Context
Scenario:
Newbury Rose Investments, a real estate investment firm specializing in core-plus acquisition investments, has recently acquired a suburban office property named Cambridge Corporate Center in the outskirts of Boston, MA. The property is a 150,000 square-foot Class B office building constructed in the late 1990s, located in a growing suburban area with a mix of corporate tenants and tech startups.
Context:
Cambridge Corporate Center is currently 92% leased, with a diverse tenant mix that includes both long-term leases signed five to seven years ago and newer leases signed within the last 12 months. The average Contract Rent across the property is $32 per square foot per year, which is the rent that is being collected under the existing lease agreements with the tenants.
Market Dynamics:
The suburban Boston office market has seen significant rent growth over the past two years due to increased demand from companies looking to move away from the high costs of downtown Boston. Currently, Market Rent for similar Class B office space in the area is approximately $38 per square foot per year.
Analysis:
The disparity between the current Contract Rent ($32 per square foot) and the Market Rent ($38 per square foot) presents an opportunity for Newbury Rose Investments. As leases come up for renewal, the firm can potentially increase rents to align more closely with the market rates, thereby increasing the property’s Net Operating Income (NOI). This strategy would likely enhance the value of Cambridge Corporate Center over the investment horizon, especially given the rising demand in the area.
Example Calculation:
Assuming a 10,000 square-foot tenant is up for lease renewal:
- Current Contract Rent: $32 per square foot x 10,000 SF = $320,000 per year
- Potential Market Rent: $38 per square foot x 10,000 SF = $380,000 per year
If Newbury Rose Investments successfully negotiates a renewal at market rent, they would increase annual revenue from this tenant by $60,000, directly contributing to an improved NOI and overall property valuation.
Conclusion:
In this scenario, Contract Rent represents the rent currently being collected based on existing leases, while the opportunity lies in bridging the gap between Contract Rent and Market Rent as leases expire or new tenants are brought into the property. Understanding the difference between these two rent figures is crucial for Newbury Rose Investments in executing their core-plus investment strategy and achieving their financial goals with Cambridge Corporate Center.
Frequently Asked Questions about Contract Rent in Commercial Real Estate
What is contract rent?
Contract Rent, also known as In-Place Rent, is “the rent being charged/collected on existing leases at a property.” It reflects the terms agreed upon in existing lease agreements rather than current market rates.
How is contract rent different from market rent?
Contract Rent is determined by the lease signed between the landlord and tenant, while Market Rent reflects the prevailing rates in the market at a given time.
What is the average contract rent at Cambridge Corporate Center?
The average Contract Rent across the property is $32 per square foot per year, based on the terms of current leases.
How does contract rent compare to current market rent in this case?
Market Rent for similar Class B office space in suburban Boston is approximately $38 per square foot per year—$6 more than the average Contract Rent.
Why is the gap between contract rent and market rent important?
This gap presents an opportunity to increase revenue as leases expire. Raising rents to market levels can enhance Net Operating Income and increase the property’s overall value.
What is a practical example of revenue increase through rent adjustment?
If a 10,000 SF tenant renews at $38/SF instead of $32/SF, annual rent increases from $320,000 to $380,000—an increase of $60,000 in annual income.
How does understanding contract rent support investment goals?
Recognizing the difference between contract and market rent helps investors like Newbury Rose identify income growth potential and execute a core-plus investment strategy effectively.
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