ASSET CLASSES
Office Underwriting: TI/LC, Free Rent, and the Effective Rent Discount Cascade
Key Takeaways
- Effective rent on a Class A urban office lease in 2026 lands 20–35% below face rent after the discount cascade: face less amortized TI less amortized LC less abated rent. The face is the headline; effective is the institutional math.
- TI is the largest concession on the balance sheet. Current gateway range $70–90/SF for Class A new leases — roughly 75% above pre-pandemic norms; trophy Manhattan deals peaked at $212/SF in 2024 before pulling back to $133–162/SF.
- Free rent runs 8–12 months on ten-year gateway leases (peak 14.5 in Midtown). Eight months free on a 120-month term equals 6.7% of contracted rent dollars given back — not a marketing detail, a direct NOI haircut.
- The tenant-by-tenant rollover schedule must differentiate TI/LC between new lease and renewal, layer in 6–12 months of downtime on full-floor Class A urban, and carry $25–35/SF gross lease-up OpEx on vacant space.
- Per Trepp, 57% of office CMBS loans in the 2024 maturity pool failed to pay off — lenders are back to pre-COVID standards and underwrite to effective rent, not face. The IRR drag between the two readings is typically several hundred bps on a 10-year hold.
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 a face rent of $52/SF. They open the lease abstract on the most recent comp signing and see 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 $52. The effective rent — face less amortized TI less amortized LC less abated rent over the term — lands closer to $32. The discount cascade is twenty to thirty-five percent on Class A urban deals in 2026, and that gap is the institutional reading of the office underwrite.
The tenant improvement allowance is the largest single concession on the institutional office balance sheet. Per Newmark's Q1 2026 U.S. Office Market Conditions & Trends, TI packages in major gateway markets sit roughly seventy-five percent above 2015–2019 levels. Per Bisnow's tracking of Manhattan trophy leases, TI on prime CBD deals peaked at $212/SF in 2024 and has pulled back to a $133–162/SF range in the most recent comps. Free rent on ten-year office leases in Midtown compressed from a 14.5-month peak to 12.5 months over the same window. Per CBRE's Q1 2026 U.S. Office Figures, taking rents were up 2.7% YoY to $33.35/SF and prime vacancy fell 80 bps to 12.7%, even as effective rents continued to decline because concessions absorbed the lift. The face-rent recovery is real. The effective-rent recovery is partial.
This article walks the institutional reading line by line. Face rent less amortized TI less amortized LC less abated rent equals effective rent — with a 2026 concession environment 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. By the end, every number on the page is reproducible by hand from inputs disclosed in the article.
THE 30-SECOND VERSION
Effective rent on a Class A urban office lease in 2026 lands twenty to thirty-five percent below face rent after the discount cascade: face less amortized TI ($70–90/SF current institutional range) less amortized LC (4–6% of total lease value) less abated rent (8–12 months on a ten-year term in gateway CBDs). The institutional landlord underwrites to effective rent, not face. The lender underwrites to effective rent, not face. Per Trepp, 57% of office CMBS loans in the 2024 maturity pool failed to pay off and lenders are back to pre-COVID standards. The tenant-by-tenant rollover schedule with TI/LC differentiated between new lease and renewal, downtime between leases at 6–12 months on Class A urban full-floor space, and lease-up OpEx at $25–35/SF gross during downtime — is the institutional discipline that retail office models miss. The IRR drag is the difference between underwriting to face rent and underwriting to effective rent. It is typically several hundred basis points on a 10-year hold.
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 line with the 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 inflation. Newmark's tracking of gateway-market TI packages shows the most current institutional range at $70–90/SF for Class A urban new leases, roughly seventy-five percent above the pre-pandemic norm. The peak in early-2024 trophy deals reached $212/SF before pulling back. The institutional analyst reading a Class A Midtown rent roll in 2026 is seeing TI commitments embedded in nearly every recent 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. Newmark and Cushman both report 8–12 months of free rent as the current institutional range on ten-year office leases in gateway CBDs. The peak in Midtown reached 14.5 months before compressing to 12.5 months in the most recent vintage. Class B and non-gateway concessions sit lower but still above pre-pandemic norms. Per Cushman & Wakefield's Q1 2026 U.S. MarketBeat, the concession environment is stabilizing in Class A but not normalizing. Eight months free on a 120-month term is 6.7% of contracted rent dollars given back.
Third, leasing commissions. The institutional standard is 4–6% of total lease value on new leases, typically tiered 6% / 3% / 1.5% across the term's first five / next five / remainder years, with a 50–75% step-down for renewal commissions. Per IRS rules, LCs are capitalized and amortized over the lease term as a deferred expense; 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 2% of 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 (~$2/SF annual) less abated rent (8 months free ÷ 120 = 6.7% of face = ~$3/SF annual) = $32.50/SF effective. A twenty-eight percent gap to face on a simple-average basis. Discounted to present value at the landlord's 8% cost of capital, the NER lands closer to $30.50/SF — a thirty-two percent gap. The institutional acquisitions analyst who underwrites to $45/SF face rent overstates Year 1 effective NOI by roughly $12–15/SF on every SF of new-vintage lease across the rent roll. On a 250,000 SF Class A Boston Seaport acquisition with eight tenants signed in the post-2022 concession environment, that is multiple millions of dollars of phantom NOI 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.
| Rent | Definition | What It Answers | Used By |
|---|---|---|---|
| Face rent | The contractual base rent per the lease document, before concessions, before escalations applied | What the lease says | Listing brokers, headline comps |
| Taking rent | The going-in cash rent net of Year 1 free rent only — market-reporting convention | What the tenant pays in Year 1 | CBRE / JLL / Cushman market reports |
| Effective rent / NER | Level-annuity equivalent over the lease term net of all concessions, amortized or PV-discounted | What the lease is actually worth | Institutional underwriters, lenders |
| ASC 842 straight-line rent | GAAP straight-line rent recognized on the income statement — averages concessions across the full term | What GAAP records | Tenant and landlord accountants |
Table 1. Four rent figures on every institutional office lease. Face is the headline; taking is the broker convention; effective is the institutional math; straight-line is the GAAP overlay.
Three formulas matter. The simple-averaging effective rent is the entry-level institutional read:
EFFECTIVE RENT — SIMPLE AVERAGE
Effective Rent = (Total Contracted Rent over Term − Total TI − Total LC − Total Free Rent Value) ÷ Lease Term in Months ÷ Rentable SF
Equivalent monthly walkdown: Face Monthly Rent − (TI/SF ÷ Term in Months) − (LC% × Total Rent ÷ Term in Months) − (Free Months × Face Monthly Rent ÷ Term in Months) = Simple-Average Effective Monthly Rent.
The institutional version is PV-discounted at the landlord's required return:
NET EFFECTIVE RENT — PV DISCOUNTED
NER = [PV of Rent Payments − PV of TI − PV of LC − PV of Abated Rent] ÷ Annuity Factor
Where Annuity Factor = [1 − (1 + r)−n] ÷ r at the landlord's required return r (typically 7–9% for stabilized Class A urban in 2026) over n months. TI is typically front-loaded at lease commencement; LC is paid 50% on signing / 50% on commencement (sometimes tiered 6%/3%/1.5%); free rent is taken at the front of the lease.
And the ASC 842 GAAP straight-line rent for the accounting overlay:
ASC 842 STRAIGHT-LINE RENT — GAAP
Straight-Line Rent = Total Cash Rent over Term ÷ Total Term Months
ASC 842 averages all cash rent (including escalations and free-rent months) across the full lease term. In free-rent months the tenant accrues a deferred-rent liability; the landlord books a corresponding deferred-rent asset. The result diverges materially from cash rent in Years 1–3 of every concession-heavy lease.
Reference treatment of the formulas: Wall Street Prep on net effective rent, CompStak's NER guide, Adventures in CRE's effective-rent glossary, and Norm Miller's PhD-grade Eloquens spreadsheet all 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 Four Amortized Landlord Costs
Four landlord costs amortize against face rent on every institutional office lease. Each carries a 2026 institutional range, a treatment, and a place in the effective-rent formula.
| Cost | What It Is | 2026 Range (Class A Urban) | How It Hits Effective Rent |
|---|---|---|---|
| TI allowance (new lease) | Landlord cash paid to tenant for build-out, typically reimbursed against construction draws or delivered turnkey | $70–90/SF gateway, $50–70/SF non-gateway | Amortize over lease term: TI/SF ÷ Term Years = annual face-rent reduction |
| TI allowance (renewal) | Smaller TI on lease extension; existing build-out partially preserved | 25–40% of new-lease TI ($20–40/SF gateway) | Same amortization, lower magnitude |
| Leasing commission (new) | Broker fee on signing, often split listing/tenant rep; tiered 6%/3%/1.5% across term | 4–6% of total lease value (blended) | Amortize 50% on signing / 50% on commencement; capitalize per IRS rules |
| Leasing commission (renewal) | Renewal commission, paid to tenant rep on extension | 50–75% of new-lease commission (2–3% of lease value) | Same amortization, lower magnitude |
| Free rent / abatement | Months of zero or reduced rent at lease commencement (sometimes lease milestones) | 8–12 months gateway, 6–10 non-gateway, 3–6 Class B | Months free × face rent ÷ total term months = annual face reduction |
| Capex turn / 2nd-gen build-out | Between-tenant work (paint, carpet, demising walls, HVAC repairs); landlord-funded; distinct from TI | $5–15/SF on second-generation office | Capex layer on rollover; not amortized into single-lease effective rent |
| Other concessions | Expansion options, ROFR, signage, parking, after-hours HVAC, early termination rights | Highly variable by tenant credit | Option value — typically priced at $0–5/SF amortized equivalent |
Table 2. The amortized landlord cost stack on an institutional office lease. 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 formally capitalized under both GAAP and IRS rules and amortized over the lease term. 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. 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.
Per JLL's Office Fit-Out Cost Guide 2026, actual hard construction costs for TI build-outs have outpaced general construction inflation in the 2022–2026 window, with Class A urban specialty trades (mechanical / electrical / plumbing, high-spec finishes, glazing) up 25–35% from pre-pandemic. The TI allowance landlords are committing is partly inflation 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: per FinQuery's ASC 842 walkthrough on rent abatement, the tenant accrues a deferred-rent liability in the abatement months equal to one-twelfth of the straight-line annual GAAP rent expense, and that liability burns down across the remaining lease term. The landlord's side is mirror-image. The cash flow shows zero rent for eight months and full rent for the remaining 112; the income statement shows roughly $30/SF of straight-line annual rent for all 120 months. For the institutional acquisitions analyst — who underwrites to cash, 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 per BOMA Method A. Lease economics: face rent $45/SF NNN (gross-up roughly $72/SF gross at $27/SF OpEx), $75/SF TI (institutional Class A urban midpoint), 8 months free at lease commencement, 4% blended LC, 2.5% annual escalations, 10-year term.
| Step | Computation | Result | $/SF/year |
|---|---|---|---|
| Face rent, Year 1 | $45 × 25,000 SF | $1,125,000 | $45.00 |
| Face rent, full term with 2.5% escalations | $45 × 25,000 × 11.255 annuity factor at 2.5% | $12,661,875 | $50.65 average over term |
| − Amortized TI | $75 × 25,000 = $1,875,000 ÷ 10 years | $187,500/year | −$7.50 |
| − Amortized LC | 4% × $12,661,875 = $506,475 ÷ 10 years | $50,648/year | −$2.03 |
| − Amortized free rent | 8 months × $45/SF × 25,000 ÷ 12 = $750,000 ÷ 10 | $75,000/year | −$3.00 |
| Simple-average effective rent | $45 − $7.50 − $2.03 − $3.00 (Year 1 face basis) | $32.47/SF | 27.8% gap to face |
| PV-discounted NER at 8% cost of capital | PV of rents minus PV of TI/LC/free rent, ÷ annuity factor | ~$30.50/SF | 32.2% gap to face |
Table 3. The discount cascade on a single tenant lease: 25,000 SF Class A Boston Seaport, 10-year term, $45 face / $75 TI / 8 months free / 4% LC. Simple-average effective rent lands at $32.47/SF, a 27.8% gap to face. PV-discounted NER at the landlord's 8% cost of capital lands at $30.50/SF, a 32.2% gap.
Two notes on the cascade. First, the simple-average and PV-discounted numbers differ because the concessions are front-loaded (TI at commencement, LC at signing, free rent in months 1–8) while contracted rent is spread across the full ten years with escalations. The PV math recognizes that front-loaded concessions are more valuable 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 cost of the concessions is roughly $2/SF higher on a discounted basis than on a 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. The AQ-200 Pocket: Office Lease Rollover runs 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.
The 2026 Concession Environment by Class and Submarket
The cascade above used midpoint Class A urban inputs. The institutional reading varies the inputs by building class and submarket because the 2026 office concession environment is highly bifurcated. The most current institutional ranges, pulled from Newmark Q1 2026, CBRE Q1 2026 Figures, JLL Office Dynamics, Cushman & Wakefield's Q1 2026 MarketBeat, Bisnow's trophy-lease reporting, and CRE Daily's office concessions briefings:
| Segment | TI/SF (New Lease) | Free Rent (10Y Term) | LC (Blended) | Concession Trajectory |
|---|---|---|---|---|
| Class A gateway urban (Manhattan, SF, Boston Seaport, DC) | $70–90/SF (Manhattan trophies $133–162) | 8–12 months | 4–6% | Compressing in jewel-box assets |
| Class A gateway suburban (NoVA, Westchester, Boston 128) | $50–70/SF | 6–10 months | 4–5% | Stabilizing |
| Class A non-gateway (Atlanta, Dallas, Austin, Nashville, Denver) | $40–60/SF | 4–8 months | 4–5% | Sun Belt absorption reducing concessions |
| Class B urban / suburban | $20–50/SF | 3–6 months | 4–5% | Persistent; maturity-wall stress concentrated here |
| Class C / repositioning candidates | $10–30/SF | 1–4 months | Negotiable | Concessions often replaced by sublease arbitrage or office-to-residential conversion math |
Table 4. 2026 institutional office concession environment by class and submarket. Newmark reports Class A gateway TI roughly 75% above the 2015–2019 baseline; CBRE reports Q1 2026 taking rents +2.7% YoY with prime vacancy at 12.7%; Cushman reports concessions stabilizing in Class A but persisting in Class B.
Two macro forces shape the 2026 environment. On the demand side, leasing momentum is building — CBRE reports Q1 2026 leasing activity tracking toward annual volumes that could surpass 2019 levels, with demand concentrating in Class A "jewel-box" assets in prime locations. On the supply side, JLL forecasts sub-7M SF of new completions in 2026, the lowest annual delivery since the global financial crisis, with roughly 75% of that pipeline pre-leased. The combination — demand recovery plus supply constraint — supports the Class A jewel-box concession compression Newmark is reporting. Outside that segment, the picture is materially different. Class B and Class C face the maturity wall: per Trepp, the 2026 hard maturity wall sits at $77B and 57% of office CMBS loans in the 2024 pool failed to pay off (against 36% multifamily and 21% retail), with delinquency hitting 12.34% in January 2026.
For the institutional reading: the analyst pricing a Class A urban gateway acquisition in 2026 is underwriting against concession compression that has started but not finished. The analyst pricing a Class B or C asset is underwriting against 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. The institutional assumption on Class A urban is typically 60–75% at lease expiration, with recent corporate office attendance recovery pushing the assumption up from the 2022 trough of 45–55%. 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. The institutional reading: every expiration carries a probability-weighted concession cost — renewal concession at probability of renewal, new-lease concession at probability of non-renewal — not a binary outcome.
Downtime between leases. If the existing tenant does not renew, the institutional assumption is 6–12 months on Class A urban for a full floor (longer in 2024–2026 vintage models reflecting post-pandemic absorption reality), 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 — $25–35/SF gross in 2026 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 roughly $560,000 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 5.2-year weighted-average lease term carries rollover events on roughly 48,000 SF per year on average over a ten-year hold — close to 20% of the building rolling each year on a smoothed basis.
For the institutional analyst building the rollover model: A.CRE's boolean-logic build for office TI/LC rollover is the reference for the lease-by-lease generation logic, with TI tiered between new and renewal and concession costs amortized across each generated lease. PropertyMetrics' market-leasing-assumptions framework is the analyst-training reference for the rollup discipline. The multifamily rent roll article covers 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 the lender lost a meaningful fraction of the 2024 maturity pool to that gap. Per Trepp, 57% of office CMBS loans in the 2024 maturity pool failed to pay off (vs 36% multifamily and 21% retail). Office CMBS delinquency hit 12.34% in January 2026 and 11.4% in February. The 2026 hard maturity wall sits at $77B per The Real Deal's CMBS maturity tracking and $115B of CRE loans by year-end 2026 have in-place DSCR below 1.20x. The lender is back to pre-COVID standards.
Four specifics shape the office bridge and agency-style permanent underwrite in 2026:
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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. The reserve sizing is typically $1–3/SF/year for rollover risk on stabilized Class A; higher for lease-up bridge.
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DSCR stress at effective rent. A 1.30x DSCR at face rent can stress to 0.95x at effective rent after the discount cascade. 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.
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Bridge debt structure and the refinancing wall. The 2021–2022 bridge vintage assumed strong rent growth, quick lease-ups, and refi into agency-style fixed-rate debt by 2024–2025. Reality deferred the window to 2025–2026 and a meaningful subset of borrowers are facing forced sales. The take-out math for any 2026 office bridge acquisition must reflect current effective rents, current vacancy, and current credit spreads — not the 2021 assumptions embedded in the seller's pro forma.
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Office capital markets context. Per Newmark Office Capital Markets, institutional office transaction volume began rebuilding in 2025 with capital concentrating in Class A urban gateway and Class A non-gateway with strong amenity and credit-tenant profiles. The bid-ask spread on Class B distressed has narrowed but remains material. Lender appetite tracks the same bifurcation — capital available for Class A, expensive for Class B, scarce for Class C without clear repositioning math.
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. See cash-on-cash return: levered vs unlevered for 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), tenant rent expense 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 one-twelfth of one year of straight-line GAAP rent expense, even though no cash was paid; the difference accrues as a deferred-rent liability on the balance sheet. The landlord's GAAP revenue recognition mirrors this on the asset side — deferred rent receivable in the free-rent months, burning 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 Years 1–3 of every concession-heavy lease — sometimes by twenty to thirty percent on Class A urban new vintages. 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 technical mechanics of rent abatement under ASC 842 require the tenant to compute an initial right-of-use asset and lease liability that account for the abatement months in the present-value calculation. The landlord's mechanics are mirror-image. 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
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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.
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Ignoring LC tiering. Treating LC as a flat 4–6% of total lease value when the institutional standard is tiered 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. Adventures in CRE's leasing commissions glossary entry walks the tiering structure at institutional depth.
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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 JLL 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.
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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 by 8–15% on a ten-year hold. Office buildings do not stabilize at a single number — the rollover layer is permanent across the hold and the model must reflect it.
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Conflating taking rent and effective rent. Brokers report taking rent (net of Year 1 free rent only) on the comp set because it is the cleanest single-period cash number. The institutional underwriter must convert taking rent to effective rent on every comp because taking rent overstates effective rent by 8–20% on Class A urban deals in 2026. 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 DEAL ON THE LOI
10-floor Class A office, 250,000 SF rentable per BOMA Method A, vintage 2018, Boston Seaport submarket. Asking price $625/SF = $156M. In-place rent roll 92% leased to 12 tenants with WALT 5.2 years. In-place T-12 NOI $9.4M (6.0% going-in cap on asking). Face rents averaging $52/SF across the rent roll (urban Class A taking-rent comp range $45–58). Recent comp on the 8th floor at $45/SF face / $75/SF TI / 8 months free / 4% LC / 10-year term — the lease walked in Section 5 above.
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. The weighted-average lands at $34.20/SF — a 34.2% gap to the $52/SF face average, wider than the 27.8% gap on the single 8th-floor comp because the in-place rent roll is dominated by leases signed during the 2021–2023 concession peak when TI ran $90–120/SF and free rent ran 10–14 months on Midtown trophy comps that informed Boston Seaport pricing.
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 extend past Year 10 (66,000 SF, 26%). The front-loaded distribution is execution risk — the new owner is absorbing the heaviest concession environment in the first three years of the hold while the seller's pro forma probably modeled smooth back-loaded rollover.
Step 3: Apply the renewal probability and the rollover cost layer. Institutional assumption: 65% renewal at expiration (post-pandemic recovery midpoint per JLL/CBRE data). 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. Year 1 NOI lands at $8.2M — a 12.8% haircut to the T-12 of $9.4M, and a much wider gap to the sponsor's pro forma Year 1 of $10.1M (which used face rents and did not model the rollover layer honestly).
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, reflecting the completed lease-ups at then-current market rents (assuming concession compression in Class A urban holds), continued 2.5% escalations, and stabilized OpEx. Exit at Year 10 at a 6.50% cap on stabilized NOI: $175M, or roughly $700/SF exit basis.
| Metric | Sponsor Pro Forma (Face) | Disciplined (Effective) | Delta |
|---|---|---|---|
| Year 1 NOI | $10.1M | $8.2M | −$1.9M (−18.8%) |
| Going-in cap on $156M asking | 6.47% (face basis) | 5.25% (effective basis) | −122 bps |
| Stabilized Year 5 NOI | $12.8M | $11.4M | −$1.4M (−10.9%) |
| Exit Year 10 at 6.50% cap | $197M | $175M | −$22M |
| Unlevered IRR (10-year hold) | Mid-teens | Low double digits | ~300–500 bps IRR drag |
Table 5. Sponsor pro forma (face-rent reading) vs disciplined institutional (effective-rent reading) on the 250,000 SF Boston Seaport acquisition. The going-in cap compresses 122 bps from 6.47% face to 5.25% effective; unlevered IRR drops several hundred bps; the exit value falls $22M on the rollover cost layer. 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 6.47% face-basis cap and discovering at month 18 that the actual cash NOI is 20% 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 the IRR calculator and formula article; for the cap rate math that drives the going-in and exit basis, see the cap rate calculator and formula article. The discount cascade on this deal is also the bridge between this article and the office 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 the trophy 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. Office leasing momentum is building per CBRE's Q1 2026 read — taking rents up 2.7% YoY to $33.35/SF, prime vacancy down 80 bps to 12.7%, annual leasing activity tracking to surpass 2019 levels. Supply is constrained per JLL's Office Dynamics forecast — sub-7M SF of completions in 2026, the lowest annual delivery since the global financial crisis, with roughly 75% of the pipeline pre-leased. The combination supports Class A "jewel-box" concession compression Newmark reports is already underway in the most sought-after gateway-urban assets.
Outside that segment, the maturity wall dominates. Trepp's hard-maturity tracking puts the 2026 wall at $77B and $115B of CRE loans by year-end 2026 carry in-place DSCR below 1.20x. The 2014 vintage payoff rate was 60% and the 2019 vintage payoff rate was 42% per Trepp's vintage analysis — underwriting standards tightened materially in 2024–2026. Class B and Class C carry the refinancing risk; some distressed Class C is finding the office-to-residential conversion path where the structural and submarket math supports it. The institutional acquisition thesis in 2026 concentrates on Class A urban and Class A non-gateway with strong amenity / credit-tenant profiles where the TI/LC concession environment is starting to compress and effective rents are stabilizing.
For the institutional analyst at IC: the 2026 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 (CBRE demand recovery + JLL supply constraint + Newmark concession compression in jewel-box assets + Trepp 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 do this by hand from the inputs disclosed in the article; the reader can build the same model in Apers within minutes against their actual deal.
DO IT IN APERS — THE ROLLOVER POCKET
AQ-200 Pocket: Office Lease Rollover ingests the rent roll and lease abstracts, runs the discount cascade on every lease (face less amortized TI less amortized LC less abated rent), builds the tenant-by-tenant rollover schedule with renewal probabilities and downtime, and produces a defensible effective-rent Year 1 NOI in seconds. The right entry point when the rent roll is in your hand and IC is on Friday. Model your office lease rollover →
DO IT IN APERS — THE FULL INSTITUTIONAL MODEL
AQ-201 Office Lease Rollover Model takes the same rent roll and builds the full institutional underwriting — T-12 reconciliation, tenant-by-tenant rollover schedule, TI/LC reserve sizing, bridge or agency-style debt structure, value-add execution timeline, exit waterfall, and sensitivity tables on TI/LC inflation, free-rent compression, renewal probability, and rollover downtime. The natural escalation when the deal advances from screen to IC memo. Build the full office lease rollover model →
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.
FAQ
Frequently Asked Questions
What is a tenant improvement allowance in commercial real estate?
A tenant improvement allowance (TI allowance, or TIA) is a landlord cash commitment to fund the tenant's build-out of the leased space. The landlord typically delivers TI either as a reimbursement against construction draws or as a turnkey build-out the landlord manages. TI is capitalized by the landlord and amortized over the lease term as a deferred expense — both for GAAP purposes under ASC 842 and for IRS treatment. Institutionally, TI is also priced into effective rent: the landlord's effective rent is face rent minus TI/SF divided by the lease term in years (plus the amortization of leasing commissions and free rent). In 2026, Class A urban gateway TI packages are running $70–90/SF on new leases (Manhattan trophies have reached $133–162/SF in recent comps and peaked at $212/SF in 2024 per Bisnow), Class A non-gateway $40–60/SF, and Class B $20–50/SF. Newmark reports gateway TI roughly 75% above pre-pandemic norms.
How is TI allowance calculated?
TI allowance is negotiated at lease signing and stated in dollars per rentable square foot ($/SF). The total TI commitment is TI/SF multiplied by the rentable SF. For underwriting, the institutional landlord amortizes the total TI over the lease term: TI/SF ÷ Lease Term in Years equals the annual face-rent reduction that drops effective rent. Example: $75/SF TI on a 10-year lease equals $7.50/SF/year of amortized cost, reducing a $45/SF face rent by 17% on the TI line alone. The TI hits effective rent in three additional ways: cash outflow at lease commencement (capex), GAAP straight-line treatment that smooths concessions across the term, and PV-discounted at the landlord's cost of capital. Institutional models track all four treatments.
What is the difference between face rent and effective rent on an office lease?
Face rent is the contractual base rent stated in the lease document — the headline number on the rent roll, before concessions, before escalations applied. Effective rent (or net effective rent, NER) is the level-annuity equivalent over the lease term net of all concessions: face rent less amortized TI less amortized LC less abated rent equals effective rent. On a 2026 Class A urban office lease at $45/SF face, $75/SF TI, 8 months free, 4% LC, and 10-year term, simple-average effective rent lands at $32.47/SF — a 27.8% gap to face. PV-discounted at the landlord's 8% cost of capital, NER lands at $30.50/SF — a 32.2% gap. The institutional underwriter prices the deal off effective rent. The lender underwrites DSCR off effective rent. Face rent is the headline; effective rent is the math.
How many months of free rent is typical on a 10-year office lease in 2026?
Per Newmark and Cushman & Wakefield's Q1 2026 tracking, the institutional range on 10-year office leases is 8–12 months in Class A gateway CBDs, 6–10 months in Class A non-gateway, and 3–6 months in Class B. Midtown Manhattan free rent compressed from a 14.5-month peak to 12.5 months in the most recent vintage per Bisnow. The free-rent concession amortizes against effective rent as: (Months Free × Face Rent ÷ Total Term Months) per year. Eight months free at $45/SF face on a 120-month term equals roughly $3/SF/year of amortized face reduction — about 6.7% of face on that line alone.
How are leasing commissions paid on a commercial office lease?
The institutional standard structure is 4–6% of total lease value, blended across the lease term. The most common tiered structure is 6% on the first five years, 3% on the next five, and 1.5% on any remainder, with the listing broker and tenant rep splitting per the procuring-cause rules under the Capland network and BOMA convention. Cash timing is typically 50% on lease signing and 50% at lease commencement. Renewal commissions are typically 50–75% of new-lease commissions. Per IRS rules, leasing commissions are capitalized as a deferred expense and amortized over the lease term — they hit effective rent the same way TI does. On a 10-year lease at 4% blended LC and $50/SF face, LC amortization runs roughly $2/SF/year against effective rent.
What is TI/LC in commercial real estate?
TI/LC is the combined acronym for tenant improvement allowance and leasing commissions — the two largest amortized landlord costs in the office lease economics. Both are capitalized at lease signing and amortized over the lease term per IRS rules, and both compress face rent into effective rent on the institutional underwrite. On a typical 2026 Class A urban office lease, the combined TI/LC amortization runs $9–11/SF/year against a $45–55/SF face rent — roughly a 20% face-rent compression before the free-rent concession is layered in. Lenders underwrite TI/LC reserves at $1–3/SF/year for stabilized Class A rollover risk and require the reserve funded at closing or escrowed monthly.
How do TI, LC, and free rent affect effective rent on an office lease?
Three concessions stack against face rent in the discount cascade. (1) Amortized TI: TI/SF divided by lease term in years, deducted from face rent annually. On $75/SF TI / 10-year lease: $7.50/SF/year. (2) Amortized LC: LC percentage times total lease value, divided by lease term. On 4% LC / 10-year lease / $50 face average: roughly $2/SF/year. (3) Amortized free rent: months free times face rent divided by total term months. On 8 months free / $45 face / 120-month term: roughly $3/SF/year. Stack the three on a $45/SF face: $45 − $7.50 − $2.00 − $3.00 = $32.50/SF simple-average effective rent — a 27.8% gap. PV-discounted at 8% cost of capital widens the gap to 32%.
Are leasing commissions amortized or expensed?
Per IRS treatment, leasing commissions on commercial leases are capitalized and amortized over the lease term as a deferred expense — not immediately expensed. Under ASC 842 GAAP rules, leasing commissions classified as initial direct costs of obtaining a lease are deferred and amortized on a straight-line basis over the lease term. The institutional landlord books LC as a capital asset at signing and recognizes amortization expense each period. For the institutional underwriter, LC enters effective rent through the amortization, runs through the cash flow statement at the timing of payment (typically 50% on signing, 50% on commencement, sometimes tiered 6%/3%/1.5% across the term), and shows up in DSCR calculations as a reserve requirement that the lender funds at closing or escrows monthly.
What is downtime between office leases?
Downtime is the period between an outgoing tenant's lease expiration and an incoming tenant's lease commencement on the same space. The institutional assumption in 2026 is 6–12 months on Class A urban full-floor space (longer than pre-pandemic, reflecting post-2022 absorption reality) and 3–6 months on suite-sized Class B/C space. During downtime, the landlord absorbs operating expenses ($25–35/SF gross in 2026 Class A urban — taxes, insurance, common-area, security, HVAC base load) without offsetting rent. A 25,000 SF Class A urban floor sitting vacant for 9 months at $30/SF gross OpEx absorbs $562,500 of lease-up cost before the new lease commences. The rollover schedule must capture downtime and lease-up OpEx explicitly — most retail office models miss it.
Why is office CMBS delinquency so high in 2026?
Per Trepp's hard maturity playbook tracking, 57% of office CMBS loans in the 2024 maturity pool failed to pay off (against 36% multifamily and 21% retail). Office CMBS delinquency hit 12.34% in January 2026 and 11.4% in February. The 2026 hard maturity wall sits at $77B and $115B of CRE loans by year-end 2026 carry in-place DSCR below 1.20x. The drivers: 2021–2022 bridge debt was sized against pre-pandemic absorption and rent-growth assumptions that did not materialize; post-pandemic occupancy reset to a structurally lower equilibrium in non-trophy office; the 2024 rate environment closed the refinancing window for assets that needed permanent take-outs. Class A urban gateway with strong amenity and credit-tenant profiles is largely outside the distress; Class B and Class C carry the refinancing risk and concentration of the maturity wall.
What is the institutional effective rent formula?
Three formulas matter. Simple average: Effective Rent = (Total Rent Paid over Term − Total TI − Total LC − Total Free Rent Value) ÷ Lease Term in Months ÷ Rentable SF. Equivalent monthly walkdown: Face Monthly Rent − (TI/SF ÷ Term in Months) − (LC% × Total Rent ÷ Term in Months) − (Free Months × Face Monthly Rent ÷ Term in Months). Institutional PV-discounted NER: NER = [PV of Rent Payments − PV of TI − PV of LC − PV of Abated Rent] ÷ Annuity Factor, where Annuity Factor = [1 − (1+r)^−n] ÷ r at the landlord's required return r (typically 7–9% for stabilized Class A urban in 2026) over n months. ASC 842 GAAP straight-line: Straight-Line Rent = Total Cash Rent over Term ÷ Total Term Months. The institutional underwriter uses PV-discounted NER for the comparison metric across leases of different term and concession structure.