A single-let office valued at each unexpired term, with the void, rent-free, fit-out and fees of the coming re-letting weighted by the chance the tenant stays.
It loses the present value of the re-letting cycle the expiry brings closer, weighted by the chance the tenant leaves. On an illustrative 5,000 m² office let at 1.5 million a year, value falls from 17.54 million with ten years unexpired to 13.71 million with one, 21.8 per cent less for the same rent, and the loss accelerates as expiry nears. The yield on passing rent rises from 8.55 to 10.94 per cent without the tenant, the rent or the market changing.
Worked in full in Office Real Estate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A ten-year lease and a one-year lease to the same tenant at the same rent produce identical income this year. A valuer who capitalises passing rent at one yield gives them the same value. A buyer does not, because the short lease puts a bill on the table: the void, the rent-free a new tenant will demand, the fit-out needed to win that tenant, the agents' fees and the empty-building costs. The question is how big that bill is and how much of it falls on each year of term.
| Item | Value |
|---|---|
| Area / passing rent / ERV | 5,000 m² / 1,500,000 / same, flat |
| Discount rate | 7.0% |
| Value once renewed or re-let | As a fresh ten-year lease, same model |
| Probability the tenant renews | 40% |
| If it renews: rent-free / fees | 3 months / 5% of rent |
| If it leaves: void / rent-free on the new lease | 15 months / 12 months |
| If it leaves: fit-out, per m² | 800 |
| If it leaves: letting fees / empty costs, per m² a year | 15% of rent / 100 |
| Item | Amount |
|---|---|
| Rent lost: 15 months void plus 12 months rent-free | 3,375,000 |
| Fit-out, 800 per m² | 4,000,000 |
| Empty costs during the void | 625,000 |
| Letting fees | 225,000 |
| Total | 8,225,000 |
That is 5.48 years of rent. The renewal path is far cheaper: three months of rent-free and a 5 per cent fee. With a 40 per cent chance of renewal, the expected cycle is mostly the departure case.
Value = PV(rent to expiry) + p × PV(renewal value) + (1 − p) × PV(re-let value − cycle costs)
Once renewed or re-let, the building carries a fresh ten-year lease, so it is worth what this same calculation gives at ten years unexpired. That value appears on both sides of the equation and is solved once: 17.54 million, a yield of 8.55 per cent on the rent. Capitalising the re-let rent at a yield chosen separately risks assuming the next cycle away, and with it most of the answer.
With three years left: rent to expiry is worth 4,061,227. If the tenant leaves, the 17.54 million arrives after 27 months of void and rent-free, less the fit-out, fees and empty costs: 8,509,828 in today's money. If it renews, 14,016,956. Weighted 60/40 and added to the rent: 14.77 million.
Solving the re-let value this way is what keeps the answer honest. Every buyer after this one faces the same cycle at the end of each lease, so the value of a let building already carries the expected cost of all future cycles; only their timing differs with the unexpired term.
| Years unexpired | Value (m) | Yield on passing rent | Change vs ten years | Loss per year of term (m) |
|---|---|---|---|---|
| 10 | 17.54 | 8.55% | 0.0% | |
| 7 | 16.51 | 9.08% | −5.9% | 0.34 |
| 5 | 15.70 | 9.55% | −10.5% | 0.41 |
| 3 | 14.77 | 10.15% | −15.8% | 0.46 |
| 2 | 14.26 | 10.52% | −18.7% | 0.51 |
| 1 | 13.71 | 10.94% | −21.8% | 0.55 |
Two things stand out. First, the yield on passing rent drifts out by almost 2.4 points over the run-off, from 8.55 to 10.94 per cent, with nothing changing but the calendar. Second, the loss per year rises from 0.34 million to 0.55 million as expiry approaches: the cycle is discounted less each year, and fewer years of rent remain to dilute it.
| Renewal probability | Value, 3 years (m) | Value, 10 years (m) | Discount for the short lease |
|---|---|---|---|
| 0% | 10.86 | 15.11 | −28.1% |
| 20% | 12.77 | 16.30 | −21.6% |
| 40% | 14.77 | 17.54 | −15.8% |
| 60% | 16.87 | 18.85 | −10.5% |
| 80% | 19.07 | 20.22 | −5.7% |
Renewal probability moves value more than term does. At three years unexpired, going from a tenant that has already signed elsewhere to one that is 80 per cent likely to stay lifts value from 10.86 million to 19.07 million, far more than the whole ten-year run-off at 40 per cent. A three-year lease to a likely stayer is worth 5.7 per cent less than a ten-year lease; to a certain leaver, 28.1 per cent less. Evidence on the tenant's plans, its space needs and the building's competitiveness, is the most valuable due diligence on a short-let office.
For an owner, the same table is a timetable. The best moment to negotiate an extension or a regear is while years remain to trade: each year of term bought back early recovers value that otherwise drains away fastest in the final two years.
Adjusting the yield by feel. Moving the ten-year 8.55 per cent to, say, 9.5 per cent "for the short lease" gives 15.79 million on this rent, 6.9 per cent above the cash-flow value at three years, and says nothing about whether the risk is the void, the fit-out or the tenant's intentions. The cash flow puts a number on each. The same cycle sits behind the capital-adjusted yield, and a tenant break is the same problem with a shorter fuse, as in what a tenant break option costs the landlord.
As a lease runs down, the re-letting cycle comes closer and value falls, from 17.54 million at ten years to 13.71 million at one here, with the loss accelerating near expiry and driven above all by whether the tenant stays. Office Real Estate builds the whole re-letting cycle into a ten-year cash flow, lease by lease, and the free workbooks for the book carry the void, the fit-out, the incentive and the letting fee as inputs you can move.
Because the costs of finding a new tenant arrive sooner and are discounted less. If the tenant leaves, this office faces 15 months of void, 12 months of rent-free, 4.0 million of fit-out, empty costs and fees: 8.225 million, or 5.48 years of rent. With ten years left that bill is distant; with one year left it is almost undiscounted.
More than the lease length itself. With three years unexpired the office is worth 15.8 per cent less than with ten at a 40 per cent renewal probability, 28.1 per cent less if the tenant is certain to leave, and 5.7 per cent less at 80 per cent. Evidence on the tenant's intentions is worth more than any yield adjustment.
Not with one yield for every lease length. On the cash flow the same 1.5 million of rent is worth 17.54 million with ten years left, a yield of 8.55 per cent, and 13.71 million with one, 10.94 per cent. A single yield applied to passing rent hides the expiry; the discount has to come from somewhere, and the cash flow shows where: void, rent-free, fit-out and fees.
This article is one calculation from Office Real Estate. 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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