When determining income for rental properties, commercial landlords rely on straight-line rents. Like the name suggests, straight-line rents are calculated steadily over the course of a lease term, even though the actual income may change month to month because of rent abatement or other lease concessions.
Straight-line rents are often used in commercial real estate leases. This is because lessees normally do not pay the same amount of rent per month. In order to attract renters, landlords may offer free or discounted months as part of their lease incentives. There might also be maintenance fees, assessments, and other charges that will cause the rental income to go up and down each month. Rather than calculate the fluctuations of rent, lessors can more easily determine income over the course of the entire lease using straight-line rents.
How to calculate straight-line rents
To calculate straight-line rent, you must take the total of all rents and divide it by the number of months in the term of the lease. In short, you are determining the average rent per month:
Total of all rent payments / number of months in the lease term
Let's look at an example:
A retail landlord is offering a storeowner a year-long lease agreement with a partial rent concession. The rental agreement states that for the first half of the year, the base rent will be $1,800 per month and for the second half of the year the rent will be $2,000 per month.
To determine the straight-line rent, calculate all of the rental revenue and divide by 12 months:
$1,800 x 6 months + $2,000 x 6 months = $22,800
$22,800 / 12 months = $1,900
For lease accounting purposes, $1,900 would be in the debit column on the balance sheet. During the first six months, $1,800 would be in the credit column for the cash reduction, and $100 would be the deferred liability. This is later reversed during the second half of the year when the rent abatement ends and the amount paid is more than the amount owed. This means that at the end of the lease term, there will be a $0 balance in the deferred liability column.
But what if the landlord charges a quarterly maintenance fee of $500 in addition to the monthly rent expense? That also gets added in to calculate the straight-line rent:
$22,800 (total rent over 12 months) + $2,000 ($500 x 4 quarters) = $24,800
$24,800 / 12 months = $2,066.66
In this case, $2,066.66 would be the straight-line rent. Especially when other fees are concerned, straight-line rents are the easier way for a landlord to budget cash flow and avoid the worry of fluctuating rent income month after month.
The pros and cons of straight-line rents
The major advantage of a straight-line rent payment is that it's much easier to calculate. In the case of rentals, rather than worry about variable lease payments made by the tenant, the straight-line rent provides the average income each month.
Aside from being an easier method of bookkeeping on an income tax basis, straight-line rents are preferable when assessing the investment potential of properties. As the rentals may vary widely based on fixed rent, lease incentives, square footage, etc., the straight-line rent method makes it easier for investors to see the fair value of an asset and its potential income.
Straight-line rents quite literally look good on paper. However, they can also be misleading when it comes to determining monthly cash flow. While everything does balance out by the end of the rental lease term, there will be those months when the net income will be lower than the actual rent.
The bottom line
Straight-line rents offer commercial landlords a better forecast of potential rental income. While the actual income may change from month to month based on the terms of the rental agreement, property owners will have a better understanding of cash flow in the short term and how it affects their bottom line in the long term.
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