A quarterly lease-up of 40,000 vacant sq ft modelled signing by signing, what it costs in lost rent, carry and leasing capital, and how far the vacancy-percentage shortcut overstates the IRR.
Model lease-up as dated signings, not as a falling vacancy percentage: a marketing downtime before the first deal, an absorption rate per quarter, rent-free from each signing, tenant improvements and leasing commissions paid when each lease is signed, and non-recoverable costs on the space still empty. On an illustrative 100,000 sq ft building bought 40 per cent vacant, that lease-up costs 5,020,000, undiscounted, and the unlevered IRR is 9.26 per cent. The usual shortcut, a vacancy allowance of 40 then 20 per cent, shows 11.11.
Worked in full in Real Estate Financial Modeling by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Lease-up is where a value-add model earns or loses its return, and where reviewers find the most generous assumptions. The rule is that every vacant suite needs a date it is let, a date it starts paying, and the capital it consumes on the way. Quarterly periods are the minimum; annual periods hide most of the cost.
| Input | Value |
|---|---|
| Lettable area / vacant at purchase | 100,000 / 40,000 sq ft |
| Market rent, net, per sq ft a year | 30.00 |
| Non-recoverable cost of vacant space, per sq ft a year | 10.00 |
| Downtime before the first signing | 2 quarters |
| Absorption after that | 5,000 sq ft a quarter |
| Rent-free from signing | 2 quarters |
| Tenant improvements / leasing commissions, per sq ft at signing | 40.00 / 8.00 |
| Price / acquisition costs | 36,000,000 / 2.0% |
| Exit after 20 quarters at / sale costs | 6.50% / 1.5% |
In-place NOI is 1,800,000, a 5.00 per cent yield on the price; fully let at market it would be 3,000,000, 8.33 per cent. The gap is what the buyer is paying for, and the lease-up is what it costs to collect it.
Signed by quarter t = MIN(vacant, absorption × MAX(0, t − downtime))
Paying by quarter t = signed by quarter t − rent-free − 1
Rent = (in-place area + paying area) × rent ÷ 4
Carry = (vacant − signed) × vacant cost ÷ 4
Leasing capital = area signed in the quarter × (TI + LC)
In Excel, with quarters across row 5: =MIN(Vacant,Absorb*MAX(0,F$5-Downtime)) for signed, and =OFFSET(F8,0,-(Free+1)) for paying, floored at zero.
Here the eight signings fall in quarters 3 to 10. The last tenant starts paying in quarter 13, which is when the building is stabilised: the date the last rent-free ends, not the date the last lease is signed.
| Year | Rent | Carry on vacant space | TI and LC | Net cash flow |
|---|---|---|---|---|
| 1 | 1,800,000 | −362,500 | −480,000 | 957,500 |
| 2 | 2,025,000 | −175,000 | −960,000 | 890,000 |
| 3 | 2,625,000 | −12,500 | −480,000 | 2,132,500 |
| 4 | 3,000,000 | 0 | 0 | 3,000,000 |
| 5 | 3,000,000 | 0 | 0 | 3,000,000 |
Year 1 rent does not move at all: the first lease is signed in quarter 3 and pays nothing until quarter 6. Year 2 is the worst year for cash, with 960,000 of leasing capital going out while the tenants signing it are still in their rent-free periods. The sale at the end of quarter 20 capitalises the stabilised 3,000,000 at 6.50 per cent, 46,153,846 gross and 45,461,538 net. The quarterly IRR, compounded to an annual rate as in how to annualise a quarterly IRR, is 9.26 per cent.
| Item | Amount |
|---|---|
| Rent not received on the 40,000 sq ft (of which rent-free 600,000) | 2,550,000 |
| Non-recoverable costs on empty space | 550,000 |
| Tenant improvements and leasing commissions | 1,920,000 |
| Total lease-up cost | 5,020,000 |
| Absorption, sq ft a quarter | Downtime 1 quarter | 2 quarters | 4 quarters |
|---|---|---|---|
| 2,500 | 8.74% (q20) | 8.55% (q21) | 8.20% (q23) |
| 5,000 | 9.46% (q12) | 9.26% (q13) | 8.89% (q15) |
| 10,000 | 9.85% (q8) | 9.65% (q9) | 9.26% (q11) |
Halving the pace costs 0.71 points of IRR and eight quarters; doubling it adds 0.39. The asymmetry is the point: a slow lease-up runs into the exit, and the sale then has to be priced net of the lease-up the buyer will finish. Rent-free matters too: with no rent-free the IRR is 9.59 per cent, with four quarters 8.95.
The common mistake is to model the vacancy as a percentage allowance, 40 per cent in year 1, 20 in year 2, nothing after, on top of a full rent line. That lets income arrive the moment occupancy rises: 2,400,000 in year 2 against 2,025,000 actually received, and none of the rent-free, leasing capital or carry. On these figures the shortcut shows 11.11 per cent, 1.85 points too high, and it also hides the year 2 cash low point that drives the equity and reserve requirements. Model each signing; reserve the general vacancy allowance for stabilised years, and do not stack it on top of the lease-up.
A lease-up is a schedule of dated signings with three cash lines: rent that starts after the rent-free, carry on what is still empty, and leasing capital at signing. Here it costs 5,020,000 and the return is 9.26 per cent, not 11.11. The rent roll and debt sheets of the book's complete model, built to the same quarterly logic, are in the free workbook for this case.
One evidenced by recent take-up for comparable space in the submarket, expressed in sq ft per quarter, plus a downtime before the first signing. In the illustrative case halving absorption from 5,000 to 2,500 sq ft a quarter cuts the IRR from 9.26 to 8.55 per cent and pushes full rent from quarter 13 to quarter 21.
When the last new tenant's rent-free period has ended and it pays full rent, not when the last lease is signed. Here the last 5,000 sq ft is signed in quarter 10 but, with two quarters free, the building earns its stabilised 3,000,000 a year only from quarter 13.
Because it lets rent arrive as soon as occupancy rises and ignores rent-free, tenant improvements, leasing commissions and the cost of carrying empty space. Those total 5,020,000, undiscounted, on the illustrative building, and leaving them out raises the IRR from 9.26 to 11.11 per cent.
This article is one calculation from Real Estate Financial Modeling. 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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