Three refinements everyone agrees are necessary, actually performed. One of them runs upward, which is why nobody performs it.
A rent roll shows 3,510,250 of in-place rent against 3,872,000 at market. The gap is 361,750 a year, 10.3% above passing, and at a 6.25% capitalisation rate that is 5,788,000 of value — about 10.3% of the asset. Every offer memorandum on an under-rented building prints a number that way. Work the three refinements everyone agrees are necessary and the same rent roll is worth 807,365.
Worked in full in How to Read a Commercial Lease by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
That is a correction of 4,980,635, or 86% of the printed figure — and 8.9% of the whole asset. For comparison, the clause-by-clause value bridge that gets itemised to the dollar in most lease abstracts comes to 1,752,400 here, which is 2.84 times smaller. The small number is worked carefully; the large one is left as three sentences beginning “of course, one would refine this”.
| Tenant | Area, sf | In-place | Market | Gap / year | Years left |
|---|---|---|---|---|---|
| Anchor law firm | 25,000 | 41.75 | 44.00 | +56,250 | 2.5 |
| Technology tenant | 18,500 | 36.00 | 44.00 | +148,000 | 6.0 |
| Insurance broker | 12,000 | 48.50 | 44.00 | −54,000 | 4.0 |
| Regional bank | 9,500 | 39.00 | 44.00 | +47,500 | 1.0 |
| Coworking operator | 14,000 | 34.00 | 44.00 | +140,000 | 8.5 |
| Ground-floor retail | 6,000 | 62.00 | 66.00 | +24,000 | 3.5 |
| Total / weighted | 85,000 | 41.30 | 45.55 | +361,750 | 4.36 |
Four tenants are under market, one is over, one is a small retail unit slightly under. Weighted average lease term is 4.36 years by area and 4.17 by rent — and that second number is doing more work than it usually gets credit for, because it is the horizon over which any of this gap can be captured.
Everyone warns against capitalising a short over-market stream in perpetuity. The aggregate mark-to-market does exactly that, silently, by netting the over-market lease against the under-market ones before capitalising the total.
| The one over-market lease | Value |
|---|---|
| Over-market income, a year | 54,000 |
| Years it has left to run | 4.0 |
| Capitalised in perpetuity, as the aggregate does | 864,000 |
| Present value of the 4 years it actually has | 186,049 |
| The perpetuity overstates the penalty by | 677,951 |
Correcting this runs upward: the naive netting takes 677,951 too much off, because it treats a 4-year over-market stream as if it lasted forever. That is the one refinement that helps the seller, and it is the one nobody performs — presumably because the instinct is that refinements make numbers smaller.
A below-market lease is not producing extra rent now. It is an uplift that begins when the lease expires, so it should be valued as a perpetuity starting then, discounted back at the same rate the perpetuity uses.
| Tenant | Gap capitalised | Years to expiry | Discount factor | Present value |
|---|---|---|---|---|
| Anchor law firm | 900,000 | 2.5 | 0.859 | 773,428 |
| Technology tenant | 2,368,000 | 6.0 | 0.695 | 1,645,918 |
| Regional bank | 760,000 | 1.0 | 0.941 | 715,294 |
| Coworking operator | 2,240,000 | 8.5 | 0.597 | 1,337,987 |
| Ground-floor retail | 384,000 | 3.5 | 0.809 | 310,585 |
| Below-market total | 6,652,000 | — | — | 4,783,212 |
Time-weighting alone removes 1,868,788 — 28.1% of the gross below-market gap — and it removes it very unevenly. The coworking lease has the largest gap on the roll and 8.5 years to run, so it keeps only 60% of its face value. The regional bank’s smaller gap arrives next year and keeps 94%. A building’s mark-to-market is as much a statement about its expiry profile as about its rents.
Every expiry is either a renewal or a re-letting, and they cost very different amounts. On this building a renewal costs 32.01 per square foot in improvement allowance and commission. A re-letting costs 119.68, because it adds nine months of downtime and a much larger allowance.
| Renewal probability | Leakage per sf | Total leakage, PV | Net mark-to-market | Of the printed figure |
|---|---|---|---|---|
| 100% | 32.01 | 1,808,433 | 2,788,730 | 48.2% |
| 75% | 53.93 | 3,046,786 | 1,550,377 | 26.8% |
| 60% | 67.08 | 3,789,798 | 807,365 | 13.9% |
| 50% | 75.84 | 4,285,139 | 312,024 | 5.4% |
| 25% | 97.76 | 5,523,492 | −926,330 | -16.0% |
| 0% | 119.68 | 6,761,845 | −2,164,683 | -37.4% |
At the 60% renewal assumption the mark-to-market is worth 807,365 — 14% of what the memorandum prints. At 50% renewals it is worth 312,024. And the level at which it is worth nothing at all is a renewal rate of 43.7%, which is not a pessimistic assumption on a multi-tenant office building.
One asymmetry is worth naming, because it means the break-even renewal rate above is an understatement. The uplift is valued as a perpetuity while the leasing cost is charged once. A perpetuity of market rent implies a re-letting at every future expiry, and each of those costs again. Charge them and the break-even moves higher still.
There is a seventh item most one-page summaries name and almost none prints: the contractual-only mark-to-market, with every renewal probability set to zero. On this building it is -2,164,683. With no renewals assumed, capturing the gap costs more than the gap is worth.
That is not a rhetorical point. It is the number a buyer should put on the table when a seller argues the mark-to-market is contractual upside, because it separates what the leases promise from what a leasing team would have to deliver.
In-place rent and market rent, then the time-weighted mark-to-market net of realisation cost — not the gross gap. Weighted average lease term by area and by rent. The expiry profile with capital committed to each expiry, since that capital is the price of the uplift. Over-market income shown at present value rather than as a perpetuity. And the contractual-only figure, with renewals at zero.
Five of those six items are already in the abstract somewhere. The one that is almost never there — the cost of realising the gap — is the one that moves the answer by 86%.
This article is one calculation from How to Read a Commercial Lease. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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