OPERATIONS
Free Rent and Abatement in Commercial Leases: Effective Rent Calculation, Concession Economics, and ASC 842 Accounting
Key Takeaways
- Free rent (also called rent abatement) is a lease concession in which the tenant pays no base rent for a specified number of months, typically at the beginning of the lease term. In 2026 office markets, free rent concessions range from 6 to 18 months in tenant-favorable conditions, with a rough rule of thumb of one month free per year of lease term.
- Net effective rent is the metric that normalizes a lease for all concessions. It is calculated by taking total base rent over the lease term, subtracting the value of free rent, TI allowances, and leasing commissions, then dividing by the total rentable square footage and lease term. On a $55/SF face rent deal with 6 months free, $75/SF TI, and 4% leasing commissions, the net effective rent drops to approximately $37.44/SF.
- The NPV method is the institutional standard for comparing proposals with different concession timing. It discounts each month's net cash flow at the landlord's cost of capital (typically 7% to 9%) and solves for the level annuity payment that produces the same present value. The simple average method understates the cost of front-loaded concessions by 3% to 8% depending on lease term and discount rate.
- Under ASC 842, both lessees and lessors recognize rent expense (or revenue) on a straight-line basis over the lease term, regardless of when cash changes hands. Free rent months create a gap between cash rent and GAAP rent that shows up as a right-of-use asset adjustment for the lessee and a deferred rent receivable for the lessor.
- Free rent and TI allowances are substitutable concessions, but they are not equivalent. Free rent is simpler to administer, hits the landlord's cash flow immediately, and has no clawback mechanism. TI allowances are tied to physical improvements that revert to the landlord, can be amortized against the asset, and are partially recoverable if the tenant defaults early.
What Free Rent Actually Is
Free rent is a lease concession in which the landlord waives the tenant's obligation to pay base rent for a specified number of months during the lease term. The term "rent abatement" is used interchangeably in most institutional contexts, though some practitioners reserve "abatement" for mid-term rent relief (such as during a renovation or casualty event) and use "free rent" specifically for the concession months negotiated at lease signing.
The mechanics are straightforward. A 7-year office lease at $55.00 per square foot with 6 months of free rent means the tenant pays $0.00 in base rent for months 1 through 6 and $55.00/SF (annualized) for months 7 through 84. The total cash rent collected by the landlord over the lease term is 78 months of rent instead of 84 months. The tenant's total occupancy cost is lower, but the reduction is concentrated at the front of the lease.
Free rent serves multiple purposes in the leasing transaction. For the tenant, it reduces upfront cash outlay during the period when buildout is underway and the space is not yet productive. For the landlord, it preserves the face rent (the stated $/SF rate) at a level that supports the property's appraised value and capitalized NOI. A landlord who cuts the face rent from $55 to $50/SF permanently reduces the property's value at a 6% cap rate by approximately $83/SF. A landlord who gives 6 months free on the same $55/SF face rent reduces total rent collections by only $27.50/SF over the lease term, a far smaller economic hit.
This distinction between face rent and effective rent is the central tension in commercial lease economics. The face rent is what appears in the lease abstract, the rent roll, and the broker's marketing materials. The effective rent is what the landlord actually collects, net of all concessions, over the term. Sophisticated participants on both sides of the transaction know that the face rent is a partially constructed number. The effective rent is the number that governs the real economics.
WHY FACE RENT MATTERS TO THE LANDLORD
Property valuation in commercial real estate is driven by net operating income, which is driven by contractual rent. A landlord who reduces the face rent permanently compresses the capitalized value of the asset. A landlord who gives free rent months preserves the face rent and the associated valuation while conceding actual cash flow. The appraisal, the lender's underwriting, and the next buyer's acquisition model all key off the face rent on the rent roll. This is why landlords strongly prefer free rent concessions over rent reductions, even when the net present value to the tenant is equivalent.
2026 Market Data: Free Rent by Property Type
Free rent concessions vary significantly by property type, market, and the balance of negotiating power between landlord and tenant. The 2026 leasing environment reflects several years of divergence: office markets remain tenant-favorable in most metros outside the Sun Belt, industrial markets have tightened after two years of supply deliveries, and retail concession packages depend heavily on anchor status and co-tenancy dynamics.
The data below is drawn from institutional brokerage reports and transaction comparables tracked by firms like CompStak, which aggregates lease-level data across major markets. These ranges represent new leases (not renewals, which typically carry lower concessions) for creditworthy tenants in Class A and Class B properties.
| Property Type | Free Rent Range (Months) | Rule of Thumb | Market Conditions |
|---|---|---|---|
| Office, Class A (gateway markets) | 10 to 18 | 1.0 to 1.5 months per year of term | Tenant-favorable. Vacancy 18%+ in most gateway CBDs. Landlords compete aggressively on concessions while holding face rent. |
| Office, Class A (Sun Belt / growth markets) | 6 to 12 | 1.0 month per year of term | Balanced to tenant-favorable. New supply absorbed faster, but sublease overhang persists. |
| Office, Class B | 8 to 15 | 1.0 to 1.25 months per year of term | Tenant-favorable. Class B competes with both Class A (on price) and remote work (on relevance). |
| Industrial / Logistics | 2 to 4 | 0.25 to 0.5 months per year of term | Landlord-favorable in most markets. Low vacancy, limited new supply. Some softening in overbuilt Sun Belt submarkets. |
| Retail, Inline | 1 to 3 | Flat, not scaled to term | Depends on center quality and anchor tenancy. Strong centers give minimal free rent. |
| Retail, Anchor / Junior Anchor | 3 to 6 | Negotiated as part of total package | Anchor tenants command larger packages. Free rent often paired with significant TI and exclusive-use provisions. |
| Multifamily (commercial units) | 1 to 2 | Flat | Minimal concessions outside of new lease-up periods. Often 1 month free as a move-in incentive. |
Several patterns are worth noting. First, free rent in office leasing has continued to expand through 2026. According to brokerage data from major institutional landlords, the median office lease signed in Manhattan in Q2 2026 included 14 months of free rent on a 10-year term. In San Francisco, the median was 16 months. In Austin and Nashville, where absorption has been stronger, the median was 8 to 10 months. Second, industrial free rent remains compressed. A 5-year industrial lease with 2 months free is a standard package, and many industrial deals close with zero free rent in tight markets. Third, retail free rent is highly deal-specific. A grocery anchor negotiating a 20-year lease at a new development may receive 6 months free as part of a total package that includes $100+/SF in TI allowances, exclusive-use provisions, and co-tenancy protections. An inline retailer at the same center might receive 1 month or none.
Net Effective Rent: The Real Cost of the Lease
Net effective rent (also called effective rent or net rent) is the metric that normalizes a lease across all concessions to produce a single, comparable $/SF figure. It is the most important number in lease economics because it captures what the landlord actually collects and what the tenant actually pays, net of free rent, TI allowances, leasing commissions, and any other concessions.
The simple effective rent formula, as described by Wall Street Prep, works as follows:
NET EFFECTIVE RENT FORMULA (SIMPLE METHOD)
Net Effective Rent = (Total Base Rent - Free Rent Value - TI Allowance - Leasing Commissions) / (RSF x Lease Term in Years)
Worked Example: Simple Method
Consider a 10,000 RSF office lease with the following terms:
- Face rent: $55.00/SF/year
- Lease term: 7 years (84 months)
- Free rent: 6 months
- TI allowance: $75.00/SF
- Leasing commission: 4% of total gross rent
Step 1. Calculate total base rent. $55.00/SF x 10,000 SF x 7 years = $3,850,000.
Step 2. Calculate the free rent value. $55.00/SF x 10,000 SF x (6/12 year) = $275,000. Alternatively, 6 months of rent at $55.00/SF annualized = $27.50/SF x 10,000 SF = $275,000.
Step 3. Calculate the TI cost to the landlord. $75.00/SF x 10,000 SF = $750,000.
Step 4. Calculate the leasing commission. 4% x $3,850,000 total gross rent = $154,000. On a per-SF basis, that is $154,000 / 10,000 SF = $15.40/SF over the lease term, or approximately $2.20/SF/year.
Step 5. Calculate net effective rent. ($3,850,000 - $275,000 - $750,000 - $154,000) / (10,000 SF x 7 years) = $2,671,000 / 70,000 = $38.16/SF/year.
The face rent is $55.00/SF. The net effective rent is $38.16/SF. The difference of $16.84/SF per year represents the annualized cost of all concessions. This gap is what makes effective rent analysis essential: a broker marketing this lease will quote $55.00/SF, but the landlord nets $38.16/SF after paying for the tenant's free rent, buildout, and brokerage.
The NPV Method for Effective Rent
The simple method above treats every dollar of concession as equal regardless of when it occurs. In practice, dollars paid (or forgone) in Month 1 are more expensive than dollars paid in Month 84 because of the time value of money. A landlord who gives 6 months of free rent at the start of a lease bears a higher present-value cost than a landlord who gives the same 6 months spread across the lease term (say, 1 month free at the start of each year).
The NPV method accounts for this by discounting all cash flows to present value and solving for the level annuity payment (the constant monthly or annual rent) that produces the same NPV. This is the institutional standard for comparing lease proposals, and it is the method used by acquisition analysts when underwriting a property with in-place leases.
NPV Effective Rent: Worked Example
Using the same 10,000 RSF office lease from above. Assume the landlord's discount rate (cost of capital) is 8.0% annually, or 0.6667% monthly.
Step 1. Lay out the monthly cash flows. Months 1 through 6: $0 (free rent period). Months 7 through 84: $55.00/SF annualized, or $4.583/SF per month. Total of 78 paying months out of 84.
Step 2. Deduct the landlord's concession costs. The TI allowance of $75.00/SF is paid at lease commencement (Month 0). The leasing commission of $15.40/SF (total over the term) is also paid at commencement. Combined upfront cost: $90.40/SF.
Step 3. Discount all cash flows to present value. The PV of 78 months of rent at $4.583/SF/month, discounted at 0.6667%/month, starting in Month 7 through Month 84, equals approximately $295.62/SF. The PV of upfront costs is $90.40/SF (already at present value). Net PV of landlord cash flows: $295.62 - $90.40 = $205.22/SF.
Step 4. Solve for the level annuity. The NPV effective rent is the constant monthly payment over 84 months that, discounted at 0.6667%/month, equals $205.22/SF. Using the present value of an annuity formula: PMT = PV / [(1 - (1+r)^-n) / r]. PMT = $205.22 / [(1 - (1.006667)^-84) / 0.006667] = $205.22 / 63.59 = $3.227/SF/month, or $38.73/SF/year.
Compare this to the simple method result of $38.16/SF/year. The NPV method produces a slightly higher effective rent ($38.73 vs $38.16) because it accounts for the time value of the front-loaded free rent concession. The 6 months of free rent at the start of the lease cost the landlord more in present-value terms than the simple amortization suggests. The difference in this example is $0.57/SF/year, or about 1.5%. On larger concession packages with longer free rent periods, the gap widens to 3% to 8%.
WHEN TO USE EACH METHOD
The simple method is adequate for quick comparisons, broker proposals, and back-of-the-envelope screening. The NPV method is required for acquisition underwriting, formal lease comparisons between proposals with different concession timing, and any situation where the landlord's cost of capital materially affects the analysis. If you are comparing a proposal with 12 months of free rent upfront against a proposal with 6 months free at signing and 6 months free at the midpoint of the term, the simple method produces the same effective rent for both. The NPV method correctly shows that the front-loaded free rent is more expensive to the landlord.
Comparing Lease Proposals
The real power of effective rent analysis emerges when comparing proposals with different concession structures. Two proposals can have dramatically different face rents, different free rent periods, different TI packages, and still produce the same (or very similar) effective rents. The challenge for both tenants and landlords is seeing through the concession packaging to the underlying economics.
Side-by-Side Comparison: Two Proposals for the Same Space
A 15,000 RSF tenant is evaluating two proposals for Class A office space in Chicago. Both proposals are for 10-year terms on comparable buildings. The tenant needs $85/SF in buildout.
| Term | Proposal A | Proposal B |
|---|---|---|
| Face rent (Year 1) | $58.00/SF | $50.00/SF |
| Annual escalation | 3.0% | 3.0% |
| Free rent | 12 months | 3 months |
| TI allowance | $95.00/SF | $45.00/SF |
| Leasing commission | 5% of gross rent | 4% of gross rent |
| Tenant out-of-pocket for buildout | $0 ($85 need, $95 TI) | $40.00/SF ($85 need, $45 TI) |
At first glance, Proposal A looks far more generous: $58/SF face rent but with 12 months free and $95/SF in TI. Proposal B looks leaner: $50/SF face rent but with only 3 months free and $45/SF in TI, leaving the tenant to fund $40/SF of buildout out of pocket.
Calculating the simple net effective rent for each (ignoring escalations for comparability):
Proposal A. Total gross rent over 10 years: $58.00 x 15,000 x 10 = $8,700,000. Less free rent: $58.00 x 15,000 x 1 year = $870,000. Less TI: $95.00 x 15,000 = $1,425,000. Less LC: 5% x $8,700,000 = $435,000. Net: $8,700,000 - $870,000 - $1,425,000 - $435,000 = $5,970,000. Net effective rent: $5,970,000 / (15,000 x 10) = $39.80/SF/year.
Proposal B. Total gross rent over 10 years: $50.00 x 15,000 x 10 = $7,500,000. Less free rent: $50.00 x 15,000 x 0.25 years = $187,500. Less TI: $45.00 x 15,000 = $675,000. Less LC: 4% x $7,500,000 = $300,000. Net: $7,500,000 - $187,500 - $675,000 - $300,000 = $6,337,500. Net effective rent: $6,337,500 / (15,000 x 10) = $42.25/SF/year.
Proposal A has a net effective rent of $39.80/SF. Proposal B comes in at $42.25/SF. Despite the lower face rent, Proposal B is more expensive for the tenant on a net effective basis because the concessions are materially smaller. The face rent difference of $8.00/SF favors Proposal B, but the concession difference of $50/SF in TI and 9 additional months of free rent in Proposal A more than offsets it.
From the landlord's perspective, Proposal A produces lower net effective revenue but preserves a higher face rent ($58 vs $50), which supports a higher appraised value on the rent roll. A landlord refinancing or selling the property in Year 3 may prefer Proposal A precisely because of the face rent, even though the cash economics are worse. This is the fundamental tension in concession packaging: the face rent serves the asset valuation, and the concessions serve the transaction.
How Free Rent Impacts Landlord IRR
Free rent does not merely reduce total rent collections. It front-loads the revenue loss, concentrating the negative cash flow impact in the early months of the lease when the landlord may also be funding TI and paying leasing commissions. The effect on the landlord's internal rate of return depends on the length of the free rent period, the face rent, the discount rate, and the lease term.
Worked Example: 5-Year Lease, 6 Months Free vs No Free Rent
Consider a 5,000 RSF office lease at $52.00/SF/year ($4,333/SF/month). 5-year term. TI allowance of $50.00/SF ($250,000 total, funded at lease commencement). The landlord's acquisition cost for this tenant space, including leasing costs, is $300,000. We compare two scenarios.
Scenario 1: No free rent. Monthly cash rent: $21,667 for all 60 months. Total rent collections: $1,300,000. Less TI and leasing costs funded at commencement: $300,000. Net cash flows: -$300,000 at Month 0, then $21,667/month for Months 1 through 60. Landlord IRR on this tenant investment: 78.6% annualized (the high IRR reflects the relatively small upfront investment compared to the rent stream).
Scenario 2: 6 months free rent at commencement. Monthly cash rent: $0 for Months 1 through 6, then $21,667/month for Months 7 through 60 (54 paying months). Total rent collections: $1,170,000. Less TI and leasing costs at commencement: $300,000. Net cash flows: -$300,000 at Month 0, $0/month for Months 1 through 6, then $21,667/month for Months 7 through 60. Landlord IRR on this tenant investment: 59.2% annualized.
The 6 months of free rent reduces the landlord's IRR from 78.6% to 59.2%, a drop of nearly 20 percentage points. The total rent reduction is only $130,000 (10% of gross rent), but the IRR impact is disproportionate because the cash flow loss is concentrated at the front of the lease, during the period when the time-value penalty is highest.
The lesson for landlords. Free rent is the most IRR-destructive form of concession because it compounds the negative-cash-flow period at the front of the lease (where TI and LC costs already create a cash deficit). A landlord choosing between giving 6 months free rent ($130,000 in rent forgone) and increasing the TI allowance by $26/SF ($130,000 in additional TI) should recognize that both cost the same in total dollars, but the TI increase has a smaller IRR impact because it merely deepens the existing Month 0 investment rather than extending the zero-cash-flow period by 6 months.
The lesson for tenants. Free rent is the most valuable concession to request because it delivers its benefit at the time when the tenant's cash flow is most constrained (during buildout and move-in). The same $130,000 of value delivered as free rent produces a higher NPV benefit to the tenant than if delivered as a rent reduction spread across the lease term.
ASC 842 Straight-Line Rent Accounting
The Financial Accounting Standards Board's ASC 842 (Leases) requires that operating lease payments be recognized on a straight-line basis over the lease term, regardless of the actual cash payment schedule. This means that free rent months do not create a GAAP rent expense of zero for the lessee or a revenue of zero for the lessor. Instead, the total rent is spread evenly across every month of the lease term, including the free rent months.
As noted by FinQuery, the straight-line requirement applies to both the lessee's rent expense and the lessor's rental revenue. The mechanics differ slightly for each party, and ASC 842 introduced the right-of-use (ROU) asset for lessees that replaces the deferred rent liability that existed under ASC 840.
Lessee Accounting: Straight-Line Rent Expense
Under ASC 842, the lessee records a right-of-use asset and a lease liability at lease commencement. The lease liability equals the present value of future lease payments (excluding the free rent months, since no payment is due). The ROU asset equals the lease liability plus any initial direct costs and prepaid rent, less any lease incentives received.
Each month, the lessee recognizes rent expense on a straight-line basis. Using the example above: total cash rent over 84 months = 78 months x $4,583/SF/month = $357,500/SF (for a 1 SF unit to keep the math clean). Wait. Let's simplify. Total rent payments over the lease: $55.00/SF x 78/12 years = $55.00 x 6.5 = $357.50/SF. Straight-line annual rent expense: $357.50 / 7 = $51.07/SF/year, or $4.256/SF/month.
During the 6 free rent months, the lessee pays $0 in cash but records $4.256/SF/month in rent expense. The difference accumulates as a reduction to the ROU asset (under ASC 842, the adjustment runs through the ROU asset rather than through a separate deferred rent liability, which was the ASC 840 treatment).
During the 78 paying months, the lessee pays $4.583/SF/month in cash but records only $4.256/SF/month in rent expense. The excess cash payment of $0.327/SF/month gradually unwinds the ROU asset adjustment.
Journal Entries: Lessee (Monthly, Per SF, Simplified)
During free rent months (Months 1 through 6):
| Account | Debit | Credit |
|---|---|---|
| Rent Expense | $4.256 | |
| ROU Asset | $4.256 |
During paying months (Months 7 through 84):
| Account | Debit | Credit |
|---|---|---|
| Rent Expense | $4.256 | |
| ROU Asset | $0.327 | |
| Cash | $4.583 |
The rent expense line is constant at $4.256/SF/month across all 84 months. The ROU asset absorbs the timing difference, decreasing during free rent months and increasing during paying months. By the end of the lease term, the cumulative ROU asset adjustment nets to zero.
Lessor Accounting: Straight-Line Rental Revenue
The lessor's treatment mirrors the lessee's. Total rental revenue over the 7-year term is recognized on a straight-line basis regardless of the cash collection schedule. Monthly rental revenue: $4.256/SF/month (the same $51.07/SF/year straight-line amount). During free rent months, the lessor records revenue with no corresponding cash receipt, creating a deferred rent receivable (sometimes called a straight-line rent receivable). During paying months, the cash receipt exceeds the revenue recognized, and the excess amortizes the deferred rent receivable.
Journal Entries: Lessor (Monthly, Per SF, Simplified)
During free rent months (Months 1 through 6):
| Account | Debit | Credit |
|---|---|---|
| Deferred Rent Receivable | $4.256 | |
| Rental Revenue | $4.256 |
During paying months (Months 7 through 84):
| Account | Debit | Credit |
|---|---|---|
| Cash | $4.583 | |
| Rental Revenue | $4.256 | |
| Deferred Rent Receivable | $0.327 |
The deferred rent receivable builds during the free rent period and amortizes over the remaining lease term. On the lessor's balance sheet, this receivable represents revenue that has been earned under GAAP but not yet collected in cash. For property owners, the deferred rent receivable is an important balance sheet item: it inflates reported assets during the early years of the lease and can create a mismatch between GAAP NOI and cash NOI.
GAAP NOI VS CASH NOI
During the free rent period, GAAP NOI includes the straight-line rental revenue even though no cash rent is being collected. Cash NOI reflects the actual $0 collection. Acquisition analysts must distinguish between the two when underwriting a property with in-place leases that include recent free rent concessions. A property purchased during the free rent period of a major tenant will show higher GAAP NOI than cash NOI. The deferred rent receivable closes over time, but if the tenant defaults before the end of the lease, the receivable becomes a write-off.
Impact on the Right-of-Use Asset
Under ASC 842, the lessee's ROU asset is calculated at lease commencement as:
ROU Asset = Lease Liability + Prepaid Rent + Initial Direct Costs - Lease Incentives Received
Free rent months affect the ROU asset calculation because they reduce the total lease payments used to calculate the lease liability. A lease with 6 months of free rent has a lower lease liability (and therefore a lower initial ROU asset) than an otherwise identical lease with no free rent. However, the straight-line rent expense is also lower (because total rent is spread over the same number of months), so the monthly amortization of the ROU asset is proportionally smaller.
The practical implication for financial reporting: a tenant with significant free rent concessions will show a lower ROU asset and lease liability on the balance sheet compared to a tenant paying the same face rent without concessions. This can affect financial ratios, particularly the debt-to-equity ratio and the current ratio, for companies with material operating leases.
Free Rent vs TI as Alternative Concessions
Free rent and tenant improvement (TI) allowances are the two primary forms of lease concessions in commercial real estate. They are economically substitutable in many situations: a landlord can offer the tenant $X in free rent or $X in TI, and the NPV to the tenant may be similar. But the two concessions have fundamentally different characteristics that affect both parties.
When Free Rent is Preferred
| Dimension | Free Rent | TI Allowance |
|---|---|---|
| Cash flow timing (landlord) | Lost revenue during free months. Front-loaded hit. | Capital outlay at commencement. Single lump sum. |
| Cash flow timing (tenant) | No rent during buildout. Cash preserved when most needed. | Reduces buildout cost. May still need cash for amounts above TI. |
| Impact on face rent | Face rent preserved. Supports appraisal and refinancing. | Face rent preserved. Same effect. |
| Clawback on early termination | No clawback. Free rent already consumed. | Unamortized TI is sometimes recoverable from the tenant's security deposit or guarantor. |
| Asset value to landlord | No residual value. Rent forgone is gone. | Physical improvements revert to the landlord. Some residual value for re-leasing. |
| Tax treatment (landlord) | Forgone revenue. No deduction, no depreciation. | Capital expenditure. Depreciable over the improvement's useful life (typically 15 years for qualified leasehold improvements under the Tax Cuts and Jobs Act, or bonus depreciated under current tax law). |
| Administrative complexity | Simple. No construction oversight, no draw schedule. | Complex. Requires construction management, lien waivers, inspections, and disbursement controls. |
| IRR impact (landlord) | Higher IRR drag per dollar (extends zero-cash-flow period). | Lower IRR drag per dollar (deepens Month 0 investment without extending zero-cash-flow period). |
Tenants prefer free rent when: they need cash flow relief during the buildout period, their buildout cost is low (and TI would be excessive relative to the work), or they want a concession with no strings attached (no construction oversight, no clawback).
Landlords prefer TI over free rent when: the improvements add residual value to the space (reducing the cost of re-leasing if the tenant vacates), the TI can be depreciated for tax purposes (creating a real tax shield), or the landlord has a low cost of capital and prefers to invest at commencement rather than forgo rent. In practice, most institutional leases include both concessions as part of a blended package. The total concession value is negotiated as a package, and the split between free rent and TI depends on the tenant's buildout needs, the landlord's financial preferences, and the market norms for the property type.
Burn-Off Analysis: Effective Rent Over the Lease Term
One of the less obvious characteristics of free rent is how it affects the effective rent calculation at different points in the lease term. The concept of "burn-off" refers to how the annualized cost of the free rent concession decreases as the lease progresses, because the free rent is amortized over the remaining term.
Consider the same 7-year lease at $55.00/SF with 6 months of free rent. At lease commencement, the annualized free rent amortization is $3.93/SF/year (6 months x $55/SF annualized, divided by 7 years). But if we calculate the effective rent at different points during the lease, the picture changes.
| Point in Lease | Remaining Term | Free Rent Amortized Over | Annual Free Rent Amortization | Effective Rent (Face Less Free Rent Only) |
|---|---|---|---|---|
| Inception (Month 1) | 84 months (7.0 years) | 7.0 years | $3.93/SF | $51.07/SF |
| End of Year 1 | 72 months (6.0 years) | 6.0 years | $4.58/SF | $55.00/SF (free rent fully consumed) |
| End of Year 3 | 48 months (4.0 years) | N/A | $0 (already consumed) | $55.00/SF |
| End of Year 5 | 24 months (2.0 years) | N/A | $0 (already consumed) | $55.00/SF |
The critical insight: once the free rent period is consumed (after Month 6 in this example), the going-forward effective rent equals the face rent. This matters for two scenarios.
Acquisition underwriting. An investor purchasing the property in Year 3 of this lease should underwrite the tenant at $55.00/SF, not $51.07/SF. The free rent has already been consumed. The in-place rent is the face rent. The deferred rent receivable on the seller's books is a GAAP artifact from straight-line accounting, not a forward cash flow item.
Lease renewal analysis. When the lease approaches expiration and the tenant negotiates a renewal, the relevant comparison is between the current face rent ($55.00/SF) and the market rent at renewal. The free rent concession from the original lease is irrelevant to the renewal negotiation because it was a one-time transaction cost, not a recurring economic feature of the lease.
The burn-off concept also matters for portfolio analytics. A landlord tracking the "effective rent" of a portfolio that includes recently signed leases with large free rent packages will see a lower portfolio effective rent than the same portfolio's going-forward cash yield. As those free rent periods expire, the portfolio effective rent "burns off" toward the face rent. Analysts who track this burn-off rate can forecast when the portfolio's cash NOI will converge with its GAAP NOI.
Five Mistakes Practitioners Make
Using face rent as the underwriting rent for recently signed leases. A lease signed 3 months ago with 12 months of free rent has collected zero cash rent so far and will collect zero for 9 more months. Underwriting this tenant at the $58/SF face rent overstates the near-term cash flow. The correct approach is to model the actual cash flow schedule (including the remaining free rent months) and use the NPV-adjusted effective rent for valuation.
Ignoring the time value of money when comparing proposals. The simple effective rent method treats all concessions as equal regardless of timing. Two proposals with the same total concession value but different timing can have materially different NPVs. A proposal with 12 months of free rent at signing is more expensive to the landlord (and more valuable to the tenant) than a proposal with 12 months of free rent spread across the lease term. Always use the NPV method when comparing proposals with different concession timing.
Confusing GAAP rent with cash rent during the free rent period. Under ASC 842, both the lessee and lessor recognize rent on a straight-line basis. The GAAP income statement shows rental revenue during free rent months even though no cash is collected. Acquisition analysts who rely on the seller's GAAP P&L without adjusting for straight-line rent will overstate the property's cash yield during periods when free rent concessions are active.
Failing to account for leasing commissions in the effective rent calculation. Leasing commissions are a real cost of leasing. A lease with 5% commissions on $55/SF face rent costs the landlord $19.25/SF over a 7-year term, or $2.75/SF/year in annualized leasing cost. Omitting commissions from the effective rent calculation overstates the landlord's net revenue by that amount. Institutional acquisition models always include leasing commissions as a concession cost in the effective rent calculation.
Treating free rent and TI as equivalent concessions without considering the landlord's IRR impact. As shown in the IRR analysis above, free rent is more destructive to the landlord's IRR per dollar of concession than TI allowances. A landlord who offers $130,000 in free rent (6 months on a 5,000 SF lease at $52/SF) bears a larger IRR hit than a landlord who offers $130,000 in additional TI. Treating the two as interchangeable in negotiation ignores this timing effect.
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AQ-201 Office Lease Rollover Model calculates net effective rent across your entire rent roll, incorporating free rent periods, TI amortization, leasing commissions, and escalation schedules. Compare lease proposals side by side, model renewal scenarios with different concession packages, and see how free rent burn-off affects your portfolio's cash NOI trajectory. Every formula auditable, every cash flow traceable.Build your lease rollover model →
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- Tenant Improvement Allowances and Market Standards. The companion guide to TI concessions. How TI allowances are sized, negotiated, disbursed, and accounted for across property types and market conditions.
- Leasing Commission Structures and Broker Compensation. The third major component of net effective rent. How leasing commissions are structured, split between listing and tenant-rep brokers, and modeled in acquisition underwriting.
- Renewal Probability and Rollover by Tenant Type. What happens when the lease expires. How renewal probability assumptions drive re-leasing cost projections, including future free rent and TI concessions.
- Co-Tenancy and Kick-Out Clauses in Retail. How co-tenancy provisions interact with rent abatement triggers. When a co-tenancy violation gives the tenant the right to reduced rent or lease termination.
- Office Lease Analysis: Gross vs NNN and Expense Stops. How the lease structure (gross, modified gross, NNN) interacts with free rent concessions and affects the effective occupancy cost.
- Office Underwriting: TI, LC, Free Rent, and Effective Rent. The acquisition analyst's playbook for underwriting office leases with concession packages. How to stress-test effective rent assumptions across leasing scenarios.
Frequently Asked Questions
How many months of free rent is standard in a commercial office lease?
In 2026, free rent concessions for new office leases typically range from 6 to 18 months depending on the market, building class, and lease term. The general rule of thumb is 1.0 to 1.5 months of free rent per year of lease term in tenant-favorable markets (gateway CBDs with high vacancy), and 0.5 to 1.0 months per year in balanced or landlord-favorable markets. A 10-year Class A office lease in Manhattan might include 12 to 15 months of free rent, while the same term in a tighter Sun Belt market might include 8 to 10 months. Industrial leases carry much lower free rent (2 to 4 months on a 5-year term), and retail varies significantly by tenant type and anchor status.
What is the difference between net effective rent and face rent?
Face rent (also called contract rent or asking rent) is the stated rental rate in the lease agreement, expressed as dollars per square foot per year. Net effective rent is the landlord's actual revenue per square foot after deducting all concession costs: free rent, tenant improvement allowances, and leasing commissions, amortized over the lease term. On a typical 2026 office lease with meaningful concessions, the net effective rent can be 25% to 35% lower than the face rent. The face rent matters for property valuation (it drives capitalized NOI and appraised value), while the effective rent matters for the actual economics of the lease transaction.
How is free rent accounted for under ASC 842?
Under ASC 842, free rent months do not create a zero rent expense (for the lessee) or zero revenue (for the lessor). Instead, total lease payments over the entire term are recognized on a straight-line basis across all months, including the free rent period. During free rent months, the lessee records rent expense with a corresponding reduction to the right-of-use (ROU) asset. The lessor records rental revenue with a corresponding increase to a deferred rent receivable. During paying months, the excess of cash rent over straight-line rent amortizes these balances. By lease expiration, both the ROU asset adjustment and the deferred rent receivable net to zero.
How do you calculate net effective rent using the NPV method?
The NPV method discounts all lease cash flows to present value using the landlord's cost of capital (typically 7% to 9%), then solves for the level annuity payment that produces the same present value over the lease term. Step 1: lay out monthly cash flows including free rent months at zero and paying months at the face rent. Step 2: deduct upfront concession costs (TI and leasing commissions) at Month 0. Step 3: discount all net cash flows to present value. Step 4: solve for the constant monthly payment using the present value of an annuity formula. The NPV method produces a slightly higher effective rent than the simple method (typically 1% to 8% higher) because it properly accounts for the time value of front-loaded concessions.
Can a landlord recover free rent if the tenant defaults early?
Generally, no. Free rent is consumed as it occurs, and once the free rent period has passed, there is no outstanding balance to recover. This is a key structural difference between free rent and TI allowances. With TI allowances, the landlord may have contractual rights to recover unamortized TI costs through the tenant's security deposit, letter of credit, or personal guaranty if the tenant defaults before the end of the lease. Some leases include an acceleration clause that requires the tenant to repay the value of free rent concessions upon an early termination event, but this provision is not standard and is heavily negotiated when included.
Does free rent affect the deferred rent receivable on the landlord's balance sheet?
Yes. Under ASC 842 straight-line accounting, the lessor recognizes rental revenue during the free rent period even though no cash is collected. This creates a deferred rent receivable (also called a straight-line rent receivable) that appears as an asset on the landlord's balance sheet. The receivable builds during the free rent months and amortizes over the remaining lease term as cash rent collections exceed the straight-line revenue amount. If the tenant defaults before the deferred rent receivable is fully amortized, the remaining balance is written off as a loss. For acquisition analysts, the deferred rent receivable is a key due diligence item because it represents revenue that has been recognized under GAAP but not yet collected.
How does free rent interact with operating expense reimbursements?
Free rent typically abates only the base rent component of the tenant's payment obligation. In most commercial leases, the tenant continues to pay its share of operating expenses (in a NNN lease) or pays operating expense escalations above the base year (in a gross or modified gross lease) during the free rent period. However, this is a negotiable point, and some leases provide a full abatement of both base rent and operating expenses during the free rent period. The lease language matters: a clause that says 'Tenant shall not be obligated to pay Base Rent during the Abatement Period' preserves the operating expense obligation, while a clause that says 'Tenant shall not be obligated to pay Rent during the Abatement Period' (where Rent is defined to include base rent and additional rent) abates everything. Landlords strongly prefer abating base rent only.
Why do landlords prefer giving free rent over reducing the face rent?
Landlords prefer free rent over face rent reductions for three reasons. First, face rent drives property valuation. A $55/SF face rent at a 6% cap rate produces a higher capitalized value than a $50/SF face rent, even if the effective rent after concessions is equivalent. This matters for refinancing, sale, and portfolio reporting. Second, free rent is temporary and burns off over the lease term. Once the free rent period ends, the going-forward rent is the full face rent. A face rent reduction is permanent for the duration of the lease. Third, free rent preserves comparable evidence. When leasing the next space in the same building, the landlord can point to the $55/SF face rent as a market comparable, even if the effective rent was lower. A $50/SF face rent becomes the comparable, making it harder to achieve higher rents on subsequent leases.