Office Underwriting: TI/LC, Free Rent, and the Effective Rent Discount Cascade

Key Takeaways

Face Rent Is the Headline, Effective Rent Is the Math

The institutional office acquisitions analyst in 2026 opens a rent roll on a Class A urban asset and sees face rents averaging $52/SF. They open the lease abstract on the most recent comp signing and see a face rent of $45/SF, a tenant improvement allowance of $75/SF, eight months of free rent, and a four percent leasing commission against a ten-year term. They reach for the calculator and the gap opens. The face is $45. The effective rent, face less amortized TI less amortized LC less abated rent over the term, lands at $32.70, 27.3 percent below face. That gap is the institutional reading of the office underwrite.

The tenant improvement allowance is usually the largest single concession on an office lease. The ranges on this page ($70–90/SF TI, 8–12 months free, 4–6% commission) are illustrative planning assumptions, not quotations from a market report. Pull current TI, free-rent, and commission figures from your own comp set and broker opinions of value before relying on any of them. The point of the cascade is structural: face rents in a market can recover while effective rents recover only in part, because concessions absorb some of the lift.

This article walks the institutional reading line by line. Face rent less amortized TI less amortized LC less abated rent equals effective rent, with an illustrative concession overlay by building class and submarket, a tenant-by-tenant rollover schedule that integrates TI/LC at every renewal, downtime between leases, lease-up OpEx on vacant space, and a worked example on a 250,000 SF Boston Seaport Class A office acquisition that carries face rent, TI/PSF, free rent, LC, lease term, and discount rate through to a defensible Year 1 NOI and a defensible effective rent. The audience is the institutional acquisitions analyst with a rent roll open in the next tab, the office leasing underwriter modeling rollover for IC, the debt broker showing a lender effective rent net of TI/LC/abatement, and the asset manager running variance analysis post-close. The lease-level numbers are reproducible by hand from the inputs shown. The building-level inputs in the worked acquisition (rent roll averages, T-12 NOI, the Year 1 and Year 5 NOI figures) are stated as illustrative assumptions, and every figure derived from them is computed.

Why TI/LC and Free Rent Are the IRR Killer

The 2026 institutional office acquisition does not fail at the face rent. The face rent on the rent roll looks plausible: $45–$58/SF on Class A urban in this example's comp set. The acquisition fails at the discount cascade. Three concession layers compress the face into the effective and each compounds against the unlevered IRR.

First, TI. The illustrative range in this article is $70–90/SF for Class A urban new leases. TI commitments are embedded in nearly every new signing, amortizing against rent for the lease's full ten years. A $80/SF TI on a ten-year lease is $8/SF of annual face-rent reduction. On a $50/SF face rent, that is a sixteen percent compression before LC and free rent are layered in.

Second, free rent. The illustrative range in this article is 8–12 months on ten-year office leases in gateway CBDs, with Class B and non-gateway concessions lower. Eight months free on a 120-month term is 6.7% of contracted rent dollars given back.

Third, leasing commissions. The illustrative range is 4–6% of total lease value on new leases, one illustrative form being tiered 6% / 3% / 1.5% across the term's first five / next five / remainder years, with renewal commissions at 50–75% of the new-lease commission. The institutional underwriter prices the cost into effective rent. On a ten-year Class A urban lease at 4% LC, the annualized amortization is roughly 4% of face rent (about $1.80/SF on a $45 face).

Stack the three concessions and the cascade against a $45/SF face rent on a ten-year Class A urban deal looks like this: face $45 less amortized TI ($75/SF ÷ 10 = $7.50/SF annual) less amortized LC ($1.80/SF annual) less abated rent (8 months free ÷ 120 = 6.7% of face = $3.00/SF annual) = $32.70/SF effective. A 27.3 percent gap to face on a simple-average basis. Discounted to present value at the landlord's 8% cost of capital, the NER lands near $27.43/SF, a 39.0 percent gap. The institutional acquisitions analyst who underwrites to $45/SF face rent overstates effective rent by $12.30/SF on a simple-average basis on every SF of new-vintage lease across the rent roll. If all 250,000 SF of a Class A Boston Seaport acquisition carried that gap, the overstatement would be about $3.1 million of income a year (250,000 × $12.30), flowing through the cap rate to the going-in basis and through the residual to the exit value. It is the IRR drag the face-rent reading hides.

Face Rent vs Effective Rent: Definitions and Formula

Four distinct rent figures live on every institutional office lease, and they answer four different questions. The institutional underwriter does not conflate them.

Table 1. Four rent figures on every institutional office lease. Face is the headline; taking is the market-report convention; effective is the institutional math; straight-line is the GAAP overlay.

Three formulas matter, plus one accounting overlay. The simple-averaging effective rent is the entry-level institutional read:

The institutional version is PV-discounted at the landlord's required return:

And the ASC 842 GAAP straight-line rent for the accounting overlay:

Reference treatment of the formulas:Wall Street Prep on net effective rentandCompStak's NER guideboth walk versions of the same math at varying depth. The institutional differentiator is not the formula; it is the discipline of carrying the formula through to the deal-level IRR.

The Amortized Landlord Cost Stack

Landlord costs amortize against face rent on every institutional office lease. Each carries an illustrative range, a treatment, and a place in the effective-rent formula.

Table 2. The amortized landlord cost stack on an institutional office lease, with illustrative ranges. TI, LC, and free rent are the three lines that drive the discount cascade; capex turn is the rollover layer; other concessions are option-value.

Two of the costs, TI and LC, are capital outlays paid around lease commencement rather than period expenses. The institutional landlord treats them as cash outflows at lease commencement on the cash flow statement and as amortized rent reductions on the effective-rent line. This article spreads both straight-line across the lease term for lease comparison; book and tax treatment are set by the owner's accountants and can differ from that spread. Both treatments matter: the cash timing drives the IRR; the amortized cost drives effective rent. The common practitioner error is to model one or the other, not both. The institutional model handles both.

The TI allowance landlords commit is partly construction-cost pass-through and partly real concession. For the institutional underwriter, the distinction does not matter at the effective-rent line: both flavors compress face the same way.

Free rent treatment matters for the ASC 842 overlay. PerFinQuery's ASC 842 walkthrough on rent abatement, the rent expense of an operating lease is recorded on a straight-line basis, with free-rent periods, abatements, and escalating payments all factored in, and the timing of non-payment periods affects how the lease liability and right-of-use asset run off on the tenant's balance sheet. On the worked lease, the cash flow shows zero rent for eight months and full rent for the remaining 112; the income statement shows $42/SF of straight-line annual rent for all 120 months ($45 × 112 ÷ 12 ÷ 10). For the institutional acquisitions analyst, who underwrites to cash and not to GAAP, the distinction is critical when reconciling sponsor pro formas built off historical financials.

The Discount Cascade: A 10-Year Class A Lease

Walk one tenant's lease through the cascade to make it concrete. The setup: a new tenant signs a 10-year lease on the entire 8th floor of a 10-floor Class A Boston Seaport office, 25,000 SF rentable perBOMA 2024 for Office Buildings. Lease economics: face rent $45/SF NNN (gross-up roughly $72/SF gross at $27/SF OpEx), $75/SF TI (inside the illustrative Class A urban range), 8 months free at lease commencement, 4% blended LC, 10-year term. Rent is held flat across the term so every figure below can be reproduced by hand; escalations would raise total contracted rent and the LC base with it.

Table 3. The discount cascade on a single tenant lease: 25,000 SF Class A Boston Seaport, 10-year term, flat $45 face / $75 TI / 8 months free / 4% LC. Simple-average effective rent lands at $32.70/SF, a 27.3% gap to face. PV-discounted NER at the landlord's 8% cost of capital lands at $27.43/SF, a 39.0% gap.

Two notes on the cascade. First, the simple-average and PV-discounted numbers differ because the concessions are front-loaded (TI and LC at commencement, free rent in months 1–8) while contracted rent is spread across the full ten years. The PV math recognizes that front-loaded concessions are more costly than the simple average suggests: the landlord is giving up cash now in exchange for rent later. At the landlord's required return of 8%, the PV-discounted NER of $27.43/SF is $5.27/SF below the $32.70 simple average. The institutional underwrite carries both numbers and uses PV-discounted NER as the comparison metric across leases of different term and concession structure.

Second, the cascade is reproducible at any face / TI / LC / free-rent / term combination. The reader can plug different inputs into the same formula and produce their own effective rent. TheAQ-200 Pocket: Office Lease Rolloverruns the cascade automatically against an uploaded rent roll and lease abstracts. We know you can do this by hand from the formula above, and the reader can build the same model in Apers within minutes against their actual deal.

Concession Ranges by Class and Submarket

The cascade above used inputs inside the Class A urban range. The institutional reading varies the inputs by building class and submarket because office concessions differ sharply by class. The table below is an illustrative planning grid, not a market survey. Replace each range with current comps and broker opinions of value for the submarket in question:

Table 4. Illustrative office concession ranges by class and submarket, used as planning assumptions in this article. They are not drawn from a market report.

Concessions move with absorption and capital-markets conditions. Where leasing demand is concentrated and new supply is thin, landlords hold firm on TI and free rent; where space is plentiful or owners face refinancing pressure, concessions persist or widen. Rather than assert a market view here, the underwriter should source current leasing, supply, and maturity data for the specific submarket and test the pro forma against both a firm-concession case and a persistent-concession case.

For the institutional reading: the analyst pricing a Class A urban gateway acquisition tests whether current concessions will hold or compress over the hold. The analyst pricing a Class B or C asset tests persistent or worsening concessions plus the lender's refinancing discipline. Same article, two different concession layers, two different IRR drag scenarios.

The Tenant-by-Tenant Rollover Schedule

Office buildings underwrite tenant-by-tenant over a ten-year DCF hold because lease terms vary widely (5/7/10/15 years), TI/LC packages vary materially between new leases and renewals, downtime between leases is material to NOI and IRR, and lease-up cost on vacant space accrues during downtime. The rollover schedule is the institutional discipline that retail office models miss. Five mechanics matter.

The lease expiration ladder. Stack the expirations by month over the ten-year hold and inspect the distribution. A flat distribution, roughly one-tenth of building SF rolling per year, is the institutional ideal; the leasing team has consistent demand to manage and rollover risk is diversified. Clustering in the first three years of the hold is execution risk: the new owner is absorbing material rollover in Year 1 underwriting. Heavy back-loading in Years 8–10 is a sale-prep signal: the seller has structured the rent roll for an exit-cap optimization. Either pattern triggers a deeper read on renewal letters issued in the 12 months pre-listing and on the leasing team's pipeline reports.

Renewal probability. A common planning assumption on Class A urban is 60–75% at lease expiration (illustrative; the worked example below uses 65%). Renewals are materially cheaper than new leases: TI typically 25–40% of new-lease TI, LC typically 50–75% of new-lease LC, free rent typically 50% of new-lease free rent (all illustrative). The institutional reading: every expiration carries a probability-weighted concession cost, renewal concession at probability of renewal and new-lease concession at probability of non-renewal, not a binary outcome.

Downtime between leases. If the existing tenant does not renew, an illustrative assumption is 6–12 months on Class A urban for a full floor and 3–6 months on suite-sized Class B space. The downtime is a vacancy layer that compounds against the rollover.

Lease-up cost on vacant space. During downtime, the landlord absorbs operating expenses (an illustrative $25–35/SF gross on Class A urban: real estate taxes, insurance, common-area expense, security, HVAC base load) without offsetting rent. This is the IRR drag the rollover schedule must capture explicitly. A full floor sitting vacant for nine months at $30/SF gross is $562,500 of OpEx absorbed on a 25,000 SF floor before the new lease commences.

TI/LC at every renewal and every new lease. The discount cascade compounds across the rollover schedule. The building's effective NOI equals the sum of leases (face rent net of concessions, weighted by occupancy) minus the rollover-cost layer (TI plus LC plus free rent plus downtime plus lease-up OpEx) minus stabilized OpEx. A 250,000 SF Class A urban building with twelve tenants and a 5.4-year weighted-average lease term (year-end expiry convention, Year 10+ bar counted as Year 10) rolls its 250,000 SF once over the ten-year hold: an average of 25,000 SF, or 10% of the building, per year. Renewals that expire again inside the hold add further events to the schedule.

For the institutional analyst building the rollover model, the lease-by-lease generation logic tiers TI between new and renewal and amortizes concession costs across each generated lease. Themultifamily rent roll articlecovers the analogous institutional discipline in a different asset class: same column-by-column diligence, different concession structure.

The Lender's View: TI/LC in the Bridge Underwrite

The lender does not underwrite to face rent. The lender underwrites to effective rent net of TI/LC and abated rent, because a loan sized on face-rent income cannot be supported by the cash actually available once concessions burn through. Lender-side maturity and delinquency statistics change quickly; source them from current lender and CMBS reporting rather than from this article.

Three specifics shape the office bridge and agency-style permanent underwrite:

• Underwritten effective rent. Lenders underwrite cash flows to NER, not face. The landlord's TI/LC obligations on rolling leases must be funded at closing (cash reserves) or escrowed monthly as a TI/LC reserve. An illustrative reserve is $1–3/SF/year for rollover risk on stabilized Class A; higher for lease-up bridge.

• DSCR stress at effective rent. Illustratively, if the full 27.3% cascade gap flowed through to cash NOI with debt service unchanged, a 1.30x DSCR at face rent would fall to about 0.94x at effective rent (1.30 × (1 − 0.2733)). The institutional acquisitions analyst on an office bridge must model the effective-rent NER to a stabilized DSCR that supports a permanent take-out at then-current credit spreads. The lender's DSCR test is the binding constraint, and the test runs against the effective number, not the face.

• Bridge debt structure and the refinancing wall. Bridge debt underwritten on strong rent growth, quick lease-ups, and a refinance into agency-style fixed-rate debt fails when those assumptions slip. The take-out math for any office bridge acquisition must reflect current effective rents, current vacancy, and current credit spreads, not the assumptions embedded in the seller's pro forma.

For the institutional acquisitions reader: the lender's effective-rent discipline mirrors the landlord's. Both numbers must be reconciled, and both must support the deal. Seecash-on-cash return: levered vs unleveredfor how the leverage math overlays on the effective-rent NOI.

ASC 842 Straight-Line Rent: The GAAP-vs-Cash Gap

The accounting overlay surprises new office analysts. Under ASC 842 (and ASC 840 before it), operating-lease rent is recognized on a straight-line basis: total cash rent over the lease term divided across every period, including free-rent months and contractual escalation steps. The result: in Month 1 of an 8-months-free lease, the tenant recognizes the level straight-line lease cost ($3.50/SF per month, or $42/SF annualized, on the worked lease) even though no cash was paid. The landlord's GAAP revenue recognition mirrors this on the asset side: straight-line rent receivable builds in the free-rent months and burns down across the term.

For the institutional underwriter this matters in three places. First, the seller's rent roll captures contractual cash rent, but the seller's GAAP P&L captures straight-line rent, and the two diverge materially in the free-rent year of every concession-heavy lease. On the worked lease, Year 1 cash rent is $15.00/SF (4 paying months × $3.75) against $42.00/SF straight-line, and the gap reverses in Years 2–10 ($45.00 cash against $42.00). Second, the lender underwrites to cash rent net of concessions, not to GAAP straight-line rent, so the lender's DSCR calculation walks off the cash flow statement and not the income statement. Third, variance analysis post-close must reconcile both numbers: the asset manager looking at the income statement six months in is reading straight-line rent and may misread soft cash collection as straight-line outperformance.

Per FinQuery's walkthrough, the tenant's initial lease liability is the present value of the lease payments over the full term, and in months with no payment the liability increases rather than runs off. The landlord books its side separately. The institutional discipline is to know which rent number is being shown on which document and never to conflate them. The cash flow statement and the lease abstract are the institutional reference; the GAAP income statement is the accounting overlay.

Five Practitioner Mistakes When Modeling Office TI/LC

• Pricing TI as a one-time capex rather than an amortized rent drag. TI is both: a cash outflow at lease commencement (capex on the cash flow statement) and an amortized rent reduction (lower effective NOI for the lease's full duration). The institutional model treats it as both. Most simple-acquisition models pick one and either understate the Year 1 cash drag (treating it purely as amortized) or understate the effective rent (treating it purely as capex). The IRR drag reads off the combination.

• Ignoring LC tiering. Treating LC as a flat 4–6% of total lease value when the lease specifies a tiered structure (one illustrative form is 6% / 3% / 1.5% across the term's first five / next five / remaining years), with first-year LC typically paid up-front 50/50 at signing and commencement. The cash timing matters for the IRR; the amortized cost matters for effective rent.

• Underwriting concession burn-off without supporting evidence. Assuming free rent drops from 10 months in Year 1 leases to 4 months in Year 5 lease-up without market-data support is a chronic sponsor pro forma habit. The discipline is to tie burn-off to specific evidence: a supply pipeline forecast that supports the submarket absorption thesis, a renovation milestone that moves the asset into a higher product tier, or comp evidence of new signings at compressed concessions. Without evidence, hold concessions flat through the rollover schedule.

• Missing the rollover layer. Modeling Year 1 effective rent correctly but treating the rest of the hold as flat without the TI/LC/free-rent/downtime layer at every renewal and every new lease. Result: stabilized NOI overstated (in the worked example below, the sponsor's Year 5 NOI of $12.8M is $1.4M above the disciplined $11.4M). Office buildings do not stabilize at a single number: the rollover layer is permanent across the hold and the model must reflect it.

• Conflating taking rent and effective rent. Market reports quote taking rent, the contract rent on executed leases before concessions, because it is a clean single-period number. The institutional underwriter must convert taking rent to effective rent on every comp. On the worked lease, taking rent of $45.00 overstates the $32.70 simple-average effective rent by 37.6% ($12.30/SF). The comp set on effective-rent basis tells you what the market is actually paying for the asset.

Worked Example: 250,000 SF Boston Seaport Acquisition

Carry the discount cascade and the rollover schedule through to a complete deal. The setup, before reading the rent roll and the lease abstracts:

The institutional reading walks the rent roll lease-by-lease, converts each face rent to effective rent via the discount cascade, and assembles a defensible Year 1 NOI. Five steps:

Step 1: Convert face rents to effective rents across the in-place rent roll. Apply the discount cascade to each of the twelve leases using the contracted TI, LC, and free-rent terms in each lease abstract. For this example, assume the weighted average lands at $34.20/SF, a 34.2% gap to the $52/SF face average ((52 − 34.20) ÷ 52). That is wider than the 27.3% gap on the single 8th-floor comp because the assumed in-place leases carry heavier TI and free rent than the comp.

Step 2: Build the tenant-by-tenant rollover schedule. Four leases roll in Years 1–3 (covering 87,000 SF, 35% of building SF), five more in Years 4–7 (97,000 SF, 39%), and three in Years 8–10+ (66,000 SF, 26%). The front-loaded distribution is execution risk: the new owner absorbs the rollover of 35% of the building in the first three years of the hold, while a seller's pro forma may have modeled a smoother cadence.

Step 3: Apply the renewal probability and the rollover cost layer. Illustrative assumption: 65% renewal at expiration, inside the 60–75% planning range. Renewal concessions: TI ~$25/SF, LC 2.5%, 4 months free, zero downtime. New-lease concessions: TI ~$75/SF, LC 4%, 8 months free, 9 months downtime average. Lease-up OpEx during downtime: $30/SF gross on the vacant SF. Weight each rollover by the probability of each path.

Step 4: Compute Year 1 disciplined NOI net of rollover cost layer. Year 1 effective gross revenue = (effective rents on in-place leases × occupied SF) − Year 1 rollover concessions − Year 1 downtime OpEx. Assume Year 1 NOI lands at $8.2M, a 12.8% haircut to the T-12 of $9.4M, and 18.8% below the sponsor's pro forma Year 1 of $10.1M (which used face rents and did not model the rollover layer).

Step 5: Carry through to stabilized NOI and exit. Stabilized Year 5 NOI after the heavy Year 1–3 rollover period and into the smoother Year 4–7 cadence: $11.4M disciplined (sponsor: $12.8M), reflecting the completed lease-ups at then-current market rents (assuming concession compression holds), with NOI rising in equal steps from Year 1 to Year 5 and then at 2.5% a year. Disciplined NOI reaches $12.9M in Year 10 and $13.2M in Year 11 (sponsor: $14.5M and $14.8M). Exit at the end of Year 10 at a 6.50% cap on Year 11 NOI: $203.4M, or about $814/SF, against $228.4M on the sponsor case. NOI is taken after the rollover cost layer, so there is no separate TI/LC capital line; flows are annual and end-of-year, with no acquisition or sale costs. On those inputs the unlevered 10-year IRR is 8.8% on the disciplined case and 10.6% on the sponsor case.

Table 5. Sponsor pro forma (face-rent reading) vs disciplined (effective-rent reading) on the 250,000 SF Boston Seaport acquisition. Inputs: $156.25M purchase price; NOI rising in equal steps from Year 1 to Year 5, then 2.5% a year; exit at the end of Year 10 at a 6.50% cap on Year 11 NOI; annual end-of-year cash flows; no acquisition or sale costs; NOI taken after the rollover cost layer. The going-in cap compresses 122 bps from 6.464% face to 5.248% effective, the exit value falls $25.0M, and unlevered IRR drops about 180 bps. This is the IRR drag the face-rent reading hides.

The institutional reading does not change whether the deal is attractive. It changes the price at which the deal is attractive. A 5.25% effective-basis going-in cap on Class A Boston Seaport in 2026 may clear an institutional buyer's hurdle, or it may not, depending on the firm's required return, the debt take-out math, and the comparison opportunity set. What the institutional reading prevents is the buyer underwriting to a 6.46% face-basis cap and discovering at month 18 that the actual cash NOI is roughly 19% below pro forma because TI/LC and abated rent absorbed the headline. The discount cascade is the discipline that surfaces the math at LOI rather than post-close.

For the IRR mechanics specifically, see theIRR calculator and formula article; for the cap rate math that drives the going-in and exit basis, see thecap rate calculator and formula article. The discount cascade on this deal is also the bridge between this article and theoffice lease analysis article on gross vs NNN expense stops(which walks how the OpEx pass-through structure inside the lease shapes face-rent vs effective-rent economics from the other direction) and thetrophy Class A vs Class B repositioning article(which walks how concession environment differs across building class and how repositioning math re-segments the asset).

The 2026 Close: Lender, Supply, Demand

The macro frame around the deal matters because the discount cascade is sensitive to the absorption direction. Where leasing demand is building and new supply is thin, concessions can compress and effective rents can recover toward face. Where space is plentiful or refinancing is difficult, concessions persist and refinancing risk dominates. Source current leasing, supply, and concession data for the specific submarket and class before setting the concession-compression assumption in the pro forma.

Outside the strongest segment, refinancing risk dominates. Class B and Class C carry the refinancing risk; some distressed Class C may find an office-to-residential conversion path where the structural and submarket math supports it. The institutional acquisition thesis concentrates on Class A urban and Class A non-gateway assets with strong amenity and credit-tenant profiles, where the TI/LC concession environment is firm or compressing and effective rents are stabilizing, and where the underwriter can support that view with current submarket evidence.

For the institutional analyst at IC: the office deal is underwritten honestly when the discount cascade is explicit, the rollover schedule integrates TI/LC at every event, the lender's effective-rent discipline is reflected in the debt sizing, and the macro frame (leasing demand, new supply, concession trend, and lender discipline) is overlaid against the deal's specific submarket and asset class. The face-rent reading is the headline. The effective-rent reading is the deal.

From the Rollover Schedule to the Institutional Pro Forma

The reading above is the institutional discipline; the modeling step is what consumes it. Once you have walked the rent roll, applied the discount cascade lease-by-lease, built the tenant-by-tenant rollover schedule with TI/LC differentiated between new and renewal, layered downtime and lease-up OpEx, and arrived at a defensible Year 1 NOI on an effective-rent basis, the next step is the institutional pro forma with debt sizing, value-add execution timeline, and exit waterfall. We know you can build the discount cascade by hand from the formulas in the article; the reader can build the same model in Apers within minutes against their actual deal.

Related Articles

• Office Lease Analysis: Gross vs NNN and Expense Stops: how the OpEx pass-through structure inside the lease shapes face vs effective from the other direction.
• Trophy Class A vs Class B Office Repositioning: how concession environment differs across building class and the math of repositioning Class B into the Class A concession band.
• IRR Calculator and Formula for Real Estate: the IRR mechanics that the discount cascade feeds through to.
• Cap Rate Calculator and Formula: the going-in and exit cap math on which the worked example's exit basis rests.
• Cash-on-Cash Return: Levered vs Unlevered: the leverage overlay on the effective-rent NOI.
• Multifamily Underwriting Fundamentals: The Rent Roll Reading Exercise: the analogous institutional discipline in a different asset class.

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