A tenant two years from expiry asks for rent-free in exchange for a new ten-year lease. The answer depends less on the rent than on what happens if the tenant leaves.
Up to the present value of what the landlord expects to lose at expiry without the regear: the void, holding costs, letting fees and new-tenant incentive if the tenant leaves, and the smaller renewal incentive if it stays, each weighted by its probability. On an illustrative 2,000 m² letting at 300 per m² expiring in two years, with a 50 per cent chance of renewal, the landlord can give up to 12.1 months' rent-free now for a new ten-year lease and still come out ahead.
Worked in full in The Real Estate Asset Manager by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Regears usually start with the tenant asking for rent-free and the landlord's agent quoting market incentives for a new letting. Both miss the point. The landlord is not comparing a regear with a new letting today; it is comparing a regear with an uncertain expiry two years out, where the tenant may renew cheaply or leave and take a year or more of income with it. That expected loss is the most the regear can be worth; the negotiation is over how much of it to hand to the tenant.
| Input | Value |
|---|---|
| Area | 2,000 m² |
| Passing rent, equal to ERV, per m² a year | 300 |
| Rent a year / a month | 600,000 / 50,000 |
| Current lease expires in | 24 months |
| Probability the tenant renews at expiry | 50% |
| Rent-free on a renewal | 3 months |
| Void if the tenant leaves | 9 months |
| Holding cost while void, per m² a year | 80 |
| Letting fee, share of first year's rent | 15% |
| Rent-free to a new tenant | 12 months |
| Discount rate | 7% |
PV(no regear) = p × PV(renewal path) + (1 − p) × PV(re-letting path)
PV(regear, x months free) = PV of ten years' rent with the first x months at zero
Break-even x: PV(regear) = PV(no regear)
Discount monthly at 1.071/12 − 1. In Excel, lay out three rows of 120 monthly cash flows (renewal, re-letting, regear), take =NPV(rate,row) of each, and Goal Seek the rent-free cell so that the regear row equals the weighted average of the other two.
Ten years of uninterrupted rent are worth 4,347,701. On the renewal path the landlord loses three months at expiry: 4,218,153, or 129,548 less. On the re-letting path it loses nine months of rent, pays 13,333 a month of holding cost, a 90,000 fee and then twelve months' rent-free: 3,309,030, or 1,038,671 less. Weighted equally, the expected value without a regear is 3,763,592, an expected loss of 584,110.
The regear breaks even at 12.1 months of rent-free granted now, worth 606,016 of rent before discounting. Because the rent-free comes at the start, its present value is close to that face amount, which is why it lands near the 584,110 expected loss.
| Option | PV | Versus no regear |
|---|---|---|
| No regear, expected | 3,763,592 | 0 |
| Regear with 6 months' rent-free | 4,053,550 | 289,958 |
| Regear with 12 months' rent-free | 3,769,183 | 5,591 |
A rough undiscounted check works in months of rent. Leaving costs nine months of void, twelve months' rent-free, the holding cost (80 over 300 of a month for each void month) and a fee worth 1.8 months: 25.2 months in all. Renewal costs three. At even odds the expected cost is 14.1 months, a little above the discounted answer because most of it falls two years or more away.
| Case | Break-even |
|---|---|
| Tenant certain to leave (0% renewal) | 22.2 |
| 30% renewal | 16.1 |
| 50% renewal, base case | 12.1 |
| 70% renewal | 8.3 |
| Tenant certain to renew | 2.6 |
| 50% renewal, 6-month void | 10.5 |
| 50% renewal, 15-month void | 15.3 |
The renewal probability dominates, and it is the input the landlord knows least about. A tenant that has already instructed an agent and viewed alternatives may be nearer a 30 per cent renewal, and up to 16.1 months of rent-free is then a reasonable price for certainty. A tenant whose fit-out is two years old and whose business depends on the location may be nearer 70 per cent, and 8.3 months is then the ceiling. The tenant's request is information about that probability: a tenant who asks for twelve months is telling you it thinks it has alternatives.
The common mistake is to benchmark the regear incentive against market incentives for a new letting, here twelve months, and either give it or refuse it on that basis. That ignores the renewal path, where the landlord would have given only three months. It also ignores the void and holding costs on the re-letting path. The two errors can cancel at even odds, as they almost do here, but at 70 per cent renewal the market benchmark overpays by nearly four months, and at 30 per cent it underpays by four.
The exit value is extra, not part of this answer. The calculation is income only. A regear also lengthens the WAULT, and a buyer at exit will usually pay a lower yield for a ten-year lease than for a two-year one, so the true break-even is higher. Count that only if the plan sells within the term and the yield evidence supports it.
Price a regear against the expected expiry, not against a new letting: the break-even here is 12.1 months, the expected loss of 584,110 converted into rent-free. Spend the negotiation finding out the renewal probability, because moving it from 50 to 70 per cent takes nearly four months off the answer. The free accept-or-hold-out workbook for the book carries the same holding-cost lines, and a related article prices the vacancy decision that follows a tenant leaving.
An agreement to replace or extend a lease before it expires, usually a new longer term in exchange for an incentive such as rent-free. In the illustrative case a tenant with two years left takes a new ten-year lease; at 50,000 a month of rent, each month of rent-free costs the landlord 50,000 before discounting.
Value the next ten years of rent without the regear as a probability-weighted mix of renewal and re-letting, including void, holding costs, fees and the new tenant's incentive. Then find the rent-free that gives the regear the same present value. Here the expected loss without a regear is 584,110, and the break-even is 12.1 months.
Yes, sharply. If the tenant is 70 per cent likely to renew anyway, the break-even falls from 12.1 to 8.3 months; if it is certain to renew, to 2.6 months. If it is only 30 per cent likely, the landlord can give 16.1 months. The tenant's alternatives matter more than the size of the unit.
This article is one calculation from The Real Estate Asset Manager. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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