Underwriting for Office Properties
The rent on the lease is not the rent you receive.
Smart Capital Center's AI reads every lease in the building, converts stated rents into what actually reaches the owner, and builds the model your team works from.
Smart Capital Center's AI reads every lease in the building, converts stated rents into what actually reaches the owner, and builds the model your team works from.
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Office underwriting is how you check whether an office building earns enough to cover its loan payments and still deliver a return. The Commercial Real Estate Development Association reports that office space removed from United States inventory through conversions and demolitions exceeded newly delivered space by 3.0 million square feet in the first quarter of 2026, only the second time that has happened in records going back to 2008. Office differs from other kinds of commercial property in one respect above all. The rent written into a lease is rarely the rent an owner collects, because free rent, fit-out contributions and leasing commissions all come out of it before any cash arrives.
Two buildings can quote the same rent per square foot and deliver returns that are nowhere near each other. The gap is in the concessions.
In office, a lease expiry is not a date in a schedule. It is a bill.
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A tenant improvement allowance, often shortened to TI allowance, is money the owner contributes towards fitting out a space for a tenant. It is usually quoted as a figure per square foot and paid once the work is done. In underwriting it is a real cash cost that has to be spread across the lease term, which is why a headline rent with a large allowance behind it is worth less than it looks.
Rent abatement, also called free rent, is a period at the start of a lease when the tenant occupies the space without paying. It is one of the most common concessions used to win a tenant. The lease still records the full rent, so a building with heavy abatement can show strong contract rents and collect very little in the first year.
Net effective rent is the rent an owner actually receives across a lease term once free rent, fit-out contributions and leasing commissions are taken out and the remainder is averaged over the term. It is the only rent figure that lets two leases be compared fairly, and it is almost always lower than the rent written on the lease.
Load factor is the share of a building's shared space, such as lobbies, corridors and restrooms, that gets added to each tenant's billed area. A tenant occupying 10,000 usable square feet in a building with a 15 percent load factor pays rent on about 11,500 square feet. A high load factor raises a tenant's real cost per usable foot and can make otherwise competitive space harder to lease.
Usable square footage is the space a tenant can actually occupy and put desks in. Rentable square footage is the space the tenant pays rent on, which includes a share of the building's common areas. Rent is quoted on rentable area, so comparing two buildings on rent per square foot without checking each one's load factor compares two different things.
A gross lease is any lease where the tenant pays a single rent and the owner covers operating costs out of it. The full service gross lease is the most complete version. In a full service gross lease, the tenant pays one rent and the owner covers the operating costs, including taxes, insurance, utilities and maintenance. It is common in office buildings. The owner carries the risk that those costs rise faster than the rent does, which is why the expense side of an office model needs more attention than a net-leased asset would.
A modified gross lease sits between a full service gross lease and a net lease. The tenant pays a base rent that covers some operating costs, and pays certain other costs separately. Because the split varies from lease to lease, each one has to be read rather than assumed, and a building with several modified gross leases can carry several different cost structures at once.
In a gross lease, the base year is the first year of the lease, and the operating costs in that year set the level the owner absorbs. The tenant only starts paying towards increases above that level. A base year set several years ago, before costs rose, leaves the owner carrying every increase since. Checking the base year on each lease is how you find out whether the recovery figures in a model are real.
A work letter is the part of a lease agreement that sets out exactly what construction work will be done to the space, who does it, who pays for it and by when. It is where the tenant improvement allowance gets defined in practice. In underwriting, the work letter is what tells you whether the allowance in the lease summary is the real number.
A stacking plan is a diagram of a building floor by floor, showing which tenant occupies which space, how much area each one has and when their lease expires. It turns a list of leases into a picture of where the risk sits, and it is usually the fastest way to see whether a building's expiries are spread out or bunched into one year.
A lease buyout is a payment made to end a lease early, either by a tenant who wants to leave or by an owner who wants the space back. In underwriting it appears in two ways. As income if a departing tenant is paying to exit, and as a cost if the plan depends on clearing a tenant out to reposition or convert the building.
| Metric | What it measures | Why it matters |
|---|---|---|
| Net operating income | Income left after operating costs, before loan payments | The starting point for value and for how much you can borrow |
| Net effective rent | Rent received across a term after concessions and commissions | The only rent figure that compares two leases fairly |
| Load factor | Share of common area added to each tenant's billed space | Changes what a quoted rent per square foot actually means |
| Weighted average lease term | Average time left on the leases, weighted by rent | How long the income is contracted before you are re-leasing |
| Tenant improvement cost per square foot | Owner's fit-out contribution per square foot leased | Usually the largest single cost of winning a tenant |
| Leasing commission | Fee paid to brokers to complete a lease | A cash cost at signing that never appears in the rent |
| Downtime months | Months a space sits empty between tenants | Turns a lease expiry into lost income with a date attached |
| Expense recovery | Share of operating costs recovered from tenants | In gross leases this is where a stale base year quietly costs the owner |
| Capital reserve per square foot | Annual allowance for lobbies, elevators and mechanical systems | Office buildings need real capital to stay leasable |
| DSCR | Income against annual loan payments | Sets how large a loan the property can support |
| Debt yield | Income against loan amount | How a lender sizes a loan without relying on interest rates |
| Going-in cap rate | Income against purchase price | Whether the price makes sense for the market and the building class |
| Exit cap rate | Assumed income against assumed sale price | Often the single biggest factor in the projected return, and wider for older buildings |
Four rows on this table link to the shared glossary rather than being defined here: weighted average lease term, DSCR, debt yield and cap rate. All four are cross-asset terms, defined once for the whole site rather than repeated on each property-type page.
In underwriting, a tenant improvement allowance is treated as a cash cost of winning the tenant, not as a discount on the rent. The owner agrees a figure per square foot, the work gets defined in the work letter, and the money is usually paid out as the work is completed. The cost then gets spread across the lease term to arrive at net effective rent. A tenant who leaves early takes the unrecovered portion with them, which is why the term matters as much as the amount.
In underwriting there is no benchmark figure that holds across markets, because the answer depends on the condition of the space, the length of the term and the tenant's credit. The test that does hold is whether the allowance pays back across the term the tenant has committed to. A large allowance on a long lease from a strong tenant can be sound. The same allowance on a short lease usually is not, and it will show up immediately once the rent is converted to net effective rent.
In underwriting, net effective rent is what makes two leases comparable. Take the total rent across the term, subtract the free rent, the fit-out contribution and the commissions, then average what is left over the term. Contract rent tells you what the lease says. Net effective rent tells you what the building earns, and the gap between the two is where office deals are won and lost.
In underwriting, load factor is what stops rent per square foot from being comparable between buildings. It is the share of common area added to each tenant's billed space, so a building with a high load factor bills more area for the same usable space. Two buildings quoting the same rent can cost a tenant very different amounts per usable foot, which affects how quickly space leases and at what level.
Valuation starts with the income the building earns after concessions, capitalized at a rate that reflects the tenant mix, the lease terms and the building's quality. Two checks sit alongside it. The upcoming expiries get costed, because a building with heavy near-term rollover carries capital costs the current income does not show. And the building gets tested against what occupiers now want, since space that cannot attract a tenant will not hold its value regardless of the current rent roll.
Conversion means changing an office building into apartments, and it changes the underwriting completely. The value stops resting on office income and starts resting on what the building can become, which depends on floor plate depth, window lines, plumbing risers, ceiling heights and local zoning. Most office buildings fail at least one of those tests. Conversions have become a real factor in the market, and the Commercial Real Estate Development Association reported office vacancy declining to 11.8 percent in the first quarter of 2026, down from 11.9 percent two quarters earlier, helped in part by space leaving inventory through conversion and demolition. Underwriting a conversion is a development exercise rather than an income one.
Underwriting in office is the process of verifying what an office building actually collects once concessions are taken out, costing every upcoming lease expiry as a capital event, rebuilding expenses at what a new owner will pay, and testing whether the resulting income supports the loan and the return. It differs from other commercial property types because the rent written into a lease is rarely the rent received, and because keeping a building leased requires ongoing capital rather than just maintenance.
To underwrite an office building, start by reading every lease and building a stacking plan that shows who occupies which space and when each lease ends. Convert the stated rents into net effective rents by taking out free rent, the owner's fit-out contribution and the leasing commissions, because that is the only basis on which two leases can be compared. Rebuild operating expenses at what a new owner will pay, and check what the base year genuinely recovers. Then cost each upcoming expiry as a capital event, including fit-out, commissions and the months the space sits empty. The deal works if that income covers debt service at your target DSCR and still clears your return threshold once those capital costs are funded.
