The payment formula behind an 'amortised over the term' clause, the balance at a break, and the valuation error it invites.
Treat the extra allowance as a loan from landlord to tenant and turn it into a level payment over the lease term at an agreed rate. On a fictional 10,000 sq ft office, 25.00 per sq ft of above-standard improvements, 250,000 in total, amortised over ten years at 8.00 per cent adds 3.64 per sq ft a year to the rent, 36,398 in all. Spread straight-line without interest it would add only 2.50, and the landlord would give away 78,289 in present value.
Worked in full in How to Read a Commercial Lease by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Most office leases carry a standard tenant improvement allowance. When the tenant wants more than the standard, the landlord can refuse, charge a lump sum, or fund the excess and recover it through the rent. The third route is common, and the lease clause that does it usually says only that the excess will be "amortised over the term at" a stated rate. That one line hides a payment formula, a repayment schedule, and a balance that matters the moment the tenant leaves early.
| Input | Value |
|---|---|
| Area | 10,000 sq ft |
| Standard TI allowance | 60.00 per sq ft |
| Allowance requested | 85.00 per sq ft |
| Excess funded by the landlord | 25.00 per sq ft, 250,000 |
| Amortisation rate in the lease | 8.00% |
| Amortisation period, monthly payments | 10 years |
| Base rent before the uplift | 42.00 per sq ft |
| Tenant break option | end of year 5 |
Monthly amortisation = Excess × i ÷ (1 − (1 + i)−n), with i = rate ÷ 12 and n = months
Rent uplift per sq ft per year = monthly amortisation × 12 ÷ area
Unamortised balance after k months = Excess × (1 + i)k − payment × ((1 + i)k − 1) ÷ i
In Excel: =PMT(Rate/12,Months,-Excess)*12/Area for the uplift and =FV(Rate/12,K,PMT(Rate/12,Months,-Excess),-Excess) for the balance after K months.
Discounted at the 8.00 per cent in the lease, the uplift is worth exactly 250,000: the landlord has lent the money and is repaid at its chosen rate. Whether that is a good trade depends on the tenant's credit. The rate in the clause is a lending rate to this tenant, unsecured, for ten years, and should be set like one; a landlord that uses its own cost of capital is pricing the tenant's risk as its own.
The break option is where the clause bites. If the tenant can leave at the end of year 5, the landlord has been repaid only part of the loan. The unamortised balance after 60 months is 149,592, or 14.96 per sq ft, about 3.9 months of total rent. A well-drafted break requires the tenant to pay that balance as a condition of exercise. If the landlord amortised the whole 85.00 package into the rent, the balance at year 5 would be 508,613, 50.86 per sq ft, and a break clause without a repayment condition would hand most of it to the tenant.
The cost of a break to the landlord goes well beyond the TI balance; what a tenant break option costs the landlord prices the rest.
| Rate | 5 years | 7 years | 10 years |
|---|---|---|---|
| 6.00% | 5.80 | 4.38 | 3.33 |
| 8.00% | 6.08 | 4.68 | 3.64 |
| 10.00% | 6.37 | 4.98 | 3.96 |
The period matters far more than the rate. Shortening from ten years to five raises the uplift by two-thirds, while two points on the rate move it by about a third of a dollar. Tenants negotiate the rate; landlords with a break option to worry about should negotiate the period, amortising to the break date rather than to expiry.
There are two, one on each side of the deal. The first is to spread the excess straight-line with no interest: 25.00 ÷ 10 = 2.50 per sq ft a year. At 8.00 per cent that stream is worth 171,711, so the landlord has funded 250,000 and given away 78,289, 31.3 per cent of the money, without noticing.
The second is on the valuation. The TI uplift is part of the passing rent, and a valuer who capitalises 45.64 per sq ft in perpetuity at a 6.50 per cent cap rate counts 36,398 a year as permanent income. Capitalised that way the uplift adds 559,974 of value, when it is worth 250,000 and stops at expiry. It is an over-market component that ends, and it should be valued as an annuity over the remaining term and deducted from the rent the next tenant will pay. What a lease mark-to-market is actually worth makes the same correction for over-market rent in general.
Amortise excess improvements with a payment formula at a rate that prices the tenant's credit: 3.64 per sq ft here, not 2.50. Tie the period to the earliest break, write the unamortised balance into the break conditions, and never let the uplift be capitalised as if it were market rent. The free workbook for this book values over-market streams over the years they actually last, which is the right treatment for this one too.
A rate that reflects lending to that tenant for the period, unsecured, not the landlord's own cost of capital. The rate matters less than people expect: on 250,000 over ten years, 6.00 per cent gives an uplift of 3.33 per sq ft, 8.00 per cent 3.64 and 10.00 per cent 3.96. Shortening the period to five years at 8.00 per cent raises it to 6.08.
Only what the lease says. If the break is conditional on repaying the unamortised balance, the landlord recovers it; if not, it is lost. On 250,000 amortised at 8.00 per cent over ten years, the balance at the end of year 5 is 149,592, or 14.96 per sq ft, about 3.9 months of total rent.
Only for the years it is paid. The uplift repays a loan and ends at expiry, so it should be valued as an annuity over the remaining term. Capitalising 36,398 a year in perpetuity at a 6.50 per cent cap adds 559,974 of value; valued at the 8.00 per cent lease rate over its ten years it is worth 250,000.
This article is one calculation from How to Read a Commercial Lease. 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.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: real estate investing, finance and fund management → · All 453 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.