Free rent and fixed bumps make reported rent and cash rent part company; the gap is a receivable that is only collected if the tenant stays.
Straight-line rent is the total rent payable over the lease term, after free rent and with every fixed escalation, divided evenly across the term. On an illustrative 10,000 sq ft, ten-year lease at $40.00 a foot rising 3 per cent a year with six months free, the tenant pays $4,385,552 in cash, so the landlord reports $438,555 a year, $43.86 a foot, from day one. The gap between that figure and the cash builds a straight-line rent receivable that peaks at $280,770 in year 4 and unwinds to zero at expiry.
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 →
Accounting standards require it: a lessor recognises operating lease income on a straight-line basis over the term unless another systematic basis is more representative (ASC 842 in the US, IFRS 16 elsewhere). The figure is correct for the income statement. It is the wrong figure for a cash flow, a DSCR or a valuation, and reading a lease well means knowing which one you are looking at.
| Input | Value |
|---|---|
| Area | 10,000 sq ft |
| Starting base rent | $40.00 per sq ft |
| Fixed annual escalation | 3.0% |
| Term | 10 years |
| Free rent at the start | 6 months |
Write out every year's contractual rent: $400,000 in year 1, $412,000 in year 2 and so on to $521,909 in year 10, a total of $4,585,552. Then remove the free rent: six months of year 1, $200,000. The tenant will pay $4,385,552 in cash over the term.
Straight-line rent = total cash rent over the term ÷ number of years (or months)
$4,385,552 ÷ 10 = $438,555 a year, $36,546 a month, $43.86 per sq ft.
In Excel, with yearly cash rent in B2:B11: =SUM(B2:B11)/10. Build the cash rents with =$B$1*(1+$B$2)^(ROW()-2) and multiply year 1 by 6/12.
| Year | Cash rent | Straight-line rent | Difference | Receivable, end of year |
|---|---|---|---|---|
| 1 | 200,000 | 438,555 | 238,555 | 238,555 |
| 2 | 412,000 | 438,555 | 26,555 | 265,110 |
| 3 | 424,360 | 438,555 | 14,195 | 279,306 |
| 4 | 437,091 | 438,555 | 1,464 | 280,770 |
| 5 | 450,204 | 438,555 | -11,648 | 269,122 |
| 6 | 463,710 | 438,555 | -25,154 | 243,967 |
| 7 | 477,621 | 438,555 | -39,066 | 204,901 |
| 8 | 491,950 | 438,555 | -53,394 | 151,507 |
| 9 | 506,708 | 438,555 | -68,153 | 83,354 |
| 10 | 521,909 | 438,555 | -83,354 | 0 |
In year 1 the landlord reports $238,555 more income than it collects. The receivable keeps growing for as long as cash rent is below the straight-line figure, peaks at $280,770 at the end of year 4, and from year 5, the first year cash exceeds $438,555, unwinds. It is an asset on the balance sheet that is only ever collected if the tenant stays to the end of the lease. If the tenant defaults in year 4, $280,770 of income already reported is written off.
| Escalator | Free months | Straight-line rent | Year-1 cash rent | Peak receivable, $ |
|---|---|---|---|---|
| 0% | 0 | 40.00 | 40.00 | 0 |
| 0% | 6 | 38.00 | 20.00 | 180,000 |
| 2% | 6 | 41.80 | 20.00 | 229,807 |
| 3% | 0 | 45.86 | 40.00 | 169,122 |
| 3% | 6 | 43.86 | 20.00 | 280,770 |
| 3% | 12 | 41.86 | 0.00 | 425,110 |
| 4% | 12 | 44.02 | 0.00 | 472,093 |
Two forces push straight-line rent away from cash, in opposite directions. Free rent lowers it: with no escalator, six months free cuts the reported rent from $40.00 to $38.00. Escalations raise it: with 3 per cent bumps and no free rent the reported figure is $45.86 against a first-year cash rent of $40.00. Most office and industrial leases have both, and the receivable is largest exactly where both are generous: a year free and 4 per cent bumps leave $472,093 on the balance sheet before the tenant has paid a cent.
Capitalising straight-line rent as if it were cash. A buyer or lender who reads $438,555 from the income statement and applies a 6.00 per cent cap rate values the lease at $7,309,253. The cash rent in the first full year of payment, year 2, is $412,000, worth $6,866,667 on the same cap rate. The difference, $442,586 or 6.4 per cent, is the averaged-in value of escalations the tenant pays only in the later years of the lease, and that a cash capitalisation would already reflect through rental growth. This is why REITs strip the straight-line adjustment out when they move from FFO to AFFO, as shown in how to calculate AFFO from FFO, and why a rent roll used for valuation should always show contractual cash rent by period.
The reverse error is quieter: treating a rising receivable as a sign of strength. It grows fastest on leases with the longest free periods, which are often the ones signed in the weakest markets.
Lease incentives paid in cash, such as a tenant improvement allowance treated as an incentive, are also spread over the term under both standards and further reduce straight-line income. The figures here are illustrative; the accounting treatment of a specific lease is a question for its auditors.
The book's six tenancies, their mark-to-market and the clause-by-clause value bridge are in the free workbook for this book. The cash side of the same incentives is worked in what headline rent delivers a target net effective rent.
Because the free rent and the low early rents of an escalating lease are averaged with the higher later ones. In the illustrative lease year-1 cash is $200,000 against $438,555 of straight-line rent, so $238,555 of income is reported but not collected, and the gap is booked as a receivable.
Yes. Free rent is part of the lease's total consideration, so the total cash payable over the term, net of the free period, is spread evenly. Six months free on a $40.00 lease with no escalator reduces straight-line rent from $40.00 to $38.00 a foot over ten years.
On cash rent. Straight-line income front-loads the escalations. At a 6.00 per cent cap rate the illustrative lease is worth $7,309,253 on its straight-line rent and $6,866,667 on its first full year of cash rent: capitalising the accounting figure overstates value by $442,586, or 6.4 per cent.
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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