The contractual formula, the landlord's economic loss, and the gap between them that the option was worth.
A lease termination fee is usually written as the landlord's unamortised tenant improvements and leasing commissions, amortised at an agreed interest rate over the term, plus a few months of rent. On an illustrative 20,000 square foot office lease terminated after six of ten years, that formula gives $834,928 of unamortised costs plus $266,667 of rent, a fee of $1,101,595. The landlord's real loss, once void, re-letting costs and a lower market rent are priced, is $1,861,894, so the clause recovers only 59 per cent of it.
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 termination clauses in North American office leases do not price the landlord's loss. They return the landlord's unrecovered investment in the tenant and add a penalty in months of rent. The landlord's investment is treated as a loan to the tenant, repaid through the rent at a stated interest rate; the fee is the outstanding balance of that loan at the termination date.
Contractual fee = unamortised (TI + leasing commissions) at the clause rate + N months of rent
Unamortised balance in Excel: =-PV(rate/12, months_left, PMT(rate/12, term_months, -cost))
Economic loss = PV of rent lost to the end of the old term − PV of rent from the replacement tenant + PV of void costs + the share of new leasing costs falling inside the old term
The first is what the tenant pays; the second is what the landlord gives up. A landlord granting the right should know the gap before signing, and a tenant negotiating an exit should know the landlord's real number, because that is where the landlord will start.
| Input | Value |
|---|---|
| Area, net rent, flat | 20,000 RSF at $40.00 |
| Term, termination at the end of month | 120 months, 72 |
| Landlord's TI at start | $60.00 per RSF |
| Leasing commission, share of term rent | 6% |
| Amortisation rate in the clause, extra rent | 8.0%, 4 months |
| Void after termination, unrecovered costs | 9 months, $12.00 per RSF a year |
| New lease: rent, rent-free, term | $38.00, 5 months, 60 months |
| New lease: TI, commission | $45.00 per RSF, 6% |
| Landlord's discount rate | 7.0% |
Step 1, the landlord's investment. TI is 20,000 × $60.00 = $1,200,000. The commission is 6 per cent of $8,000,000 of term rent, $480,000. Together: $1,680,000.
Step 2, the unamortised balance. Treated as a 120-month loan at 8.0 per cent, the monthly payment is $20,383.04. After 72 payments the balance outstanding is $834,928, 49.7 per cent of the original cost, even though 60 per cent of the term has run, because early payments are mostly interest.
Step 3, the fee. Four months of rent at $66,667 add $266,667: $1,101,595, about 16.5 months of rent.
Step 4, the landlord's economic loss. 48 months of rent remained, $3,200,000, worth $2,795,645 discounted at 7.0 per cent. The space is empty for nine months, costing $175,015 in unrecovered expenses, then let at $38.00 with five months free, so the new tenant pays for 34 of the 48 months: $1,805,689 in present value. The new lease costs $900,000 of TI and $228,000 of commission; 39 of its 60 months fall inside the old term, so 65 per cent of the cost, $696,923 in present value, is charged to the termination.
| Line | $ |
|---|---|
| Rent the old lease would have paid | 2,795,645 |
| Less rent from the replacement tenant | −1,805,689 |
| Costs during the void | 175,015 |
| Share of new TI and commission | 696,923 |
| Economic loss | 1,861,894 |
| Contractual fee | 1,101,595 |
| Shortfall borne by the landlord | 760,299 |
The clause pays 16.5 months of rent; the loss is 27.9 months. To be made whole the landlord would need the unamortised balance plus 15.4 months of rent, not four. The shortfall of $760,299 is the value of the option the landlord granted, and it should have been priced in the rent or the TI when the lease was signed. A probability-weighted view of the same exposure, for a break the tenant may or may not use, is in what a tenant break option costs the landlord.
| Void, months | Market $34.00 | Market $38.00 | Market $42.00 |
|---|---|---|---|
| 6 | 1,886,796 | 1,694,378 | 1,501,960 |
| 9 | 2,037,138 | 1,861,894 | 1,686,649 |
| 12 | 2,185,839 | 2,027,499 | 1,869,159 |
| 18 | 2,478,366 | 2,353,045 | 2,227,725 |
In none of the twelve cases does the formula cover the loss. Even a six-month void at a market rent above the contract leaves the landlord $400,365 short, because the new lease's own leasing costs and rent-free months are charged inside the old term. The fee formula only compensates the past; the loss is about the future.
The loss is measured only to the end of the old term, and it charges the new tenant's whole rent-free period to the termination while apportioning its TI and commission. That makes it a full measure rather than a minimal one: a replacement rent above the old contract also benefits the landlord after the old expiry date, which this view leaves out. A tenant negotiating the fee will argue those points; the order of magnitude of the gap survives them.
Amortising the TI and commissions straight-line. Straight-line, 48 of 120 months left is 40 per cent, $672,000, and the fee becomes $938,667, $162,928 less than the clause's own 8.0 per cent amortisation produces. Tenants sometimes propose the straight-line figure as "the unamortised cost"; the clause rate decides, and if the lease is silent on a rate, that silence is worth negotiating before signature, not at exit.
The re-letting cost per foot and the blank rent roll model that sit behind these inputs are in the free workbook for this book.
Clauses commonly add a few months of rent to the unamortised costs, but the total is what matters. In the worked case the unamortised balance plus four months comes to 16.5 months of rent, while the landlord's economic loss is 27.9 months. Making the landlord whole would take the unamortised balance plus 15.4 months of rent.
As the outstanding balance of a loan equal to the landlord's TI and commissions, repaid monthly over the term at the rate stated in the lease. $1,680,000 at 8.0 per cent over 120 months has a payment of $20,383.04 and a balance of $834,928 after 72 months, higher than the $672,000 straight-line figure.
That depends on the jurisdiction and on how the payment is structured, and needs specific tax advice. The economics do not: in the illustrative case the landlord receives $1,101,595 against a loss of $1,861,894 in present value, so the fee should be compared with the loss before tax, then each side checks its own tax treatment.
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.
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