When the measured survey comes in below the particulars, the contracted rent does not move; the reviews, the re-lettings and the exit value do.
Re-run the cash flow on the measured area and take the difference in value at the return the price implies. Contracted rents do not move, so the shortfall bites only where rent is set per square foot: at reviews, at re-lettings and at the exit. On an illustrative 36,000,000 office sold as 50,000 sq ft that measures 47,600, a 4.8 per cent shortfall costs 1,420,405, or 3.95 per cent of the price. A pro rata cut, the usual first proposal, would ask for 1,728,000.
Worked in full in Real Estate Transaction Due Diligence by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Sales particulars quote a net internal area, often taken from old lease plans, the seller's previous purchase or a survey done before a refurbishment. A buyer's measured survey regularly finds a different figure. The seller's first reply is that it does not matter: the tenants pay fixed rents, not a rate per square foot, and nothing in the leases changes. That is true today. But a valuer setting a review rent, an incoming tenant agreeing a new lease and the next buyer all price the building per square foot of the area they can measure. The shortfall is a cut in future rent, timed by the lease events, and in the exit value.
| Input | Value |
|---|---|
| Price | 36,000,000 |
| Net internal area in the particulars / measured, sq ft | 50,000 / 47,600 |
| Shortfall | 2,400 (4.8%) |
| Passing rent, each suite let at today's ERV on the quoted area | 937,500 |
| ERV per sq ft today / growth a year | 37.50 / 2% |
| Suite X: long lease, five-yearly upward-only reviews | years 6 and 11 |
| Suite Y: lease ends after year 3, void, then re-let; review | 0.5 year; year 9 |
| Exit yield on year 11 rent, end of a 10-year hold | 5.5% |
The discount rate is the one at which the cash flow on the quoted area is worth exactly the price: 6.31 per cent. The buyer is not repricing its required return, only the area.
Rent at review = max(passing rent, ERV per sq ft × measured area), upward-only
Rent at re-letting = ERV per sq ft × measured area
Adjustment = PV(cash flow, quoted area) − PV(cash flow, measured area), both at the rate implied by the price
Excel: =NPV(Rate,Quoted_CF)-NPV(Rate,Measured_CF), with exit value in the final year
Years 1 to 3. Both suites pay 937,500 under their leases. No difference.
Year 4, the re-letting. ERV has grown to 39.80. On the quoted 25,000 sq ft suite Y would re-let at 994,883 a year; on the measured 23,800, at 947,128. After half a year of void, the first year's difference is 23,877, then 47,754 a year.
Year 6, the review. ERV of 41.40 on 23,800 sq ft is 985,392 against 1,035,076 on the quoted area. Both are above the passing rent, so the upward-only clause does not protect the buyer, and the gap carries through.
| Year | Quoted | Measured | Difference |
|---|---|---|---|
| 1 to 3 | 1,875,000 | 1,875,000 | 0 |
| 4 | 1,434,941 | 1,411,064 | 23,877 |
| 5 | 1,932,382 | 1,884,628 | 47,754 |
| 6 to 8 | 2,029,958 | 1,932,520 | 97,438 |
| 9 and 10 | 2,133,506 | 2,031,098 | 102,408 |
| 11, capitalised at exit | 2,241,238 | 2,133,659 | 107,579 |
The result. At 6.31 per cent the measured cash flow is worth 34,579,595: an adjustment of 1,420,405, 3.95 per cent. The exit carries 74.7 per cent of it, because the next buyer's 5.5 per cent yield is applied to a rent that is permanently smaller: 38,793,791 against 40,749,781.
At the price first agreed, the buyer would pay 756.30 per measured sq ft, not the 720 in the particulars. At the adjusted price it pays 726.46.
| Shortfall | Measured area, sq ft | Adjustment | % of price |
|---|---|---|---|
| 2.0% | 49,000 | 591,835 | 1.64% |
| 4.8% | 47,600 | 1,420,405 | 3.95% |
| 8.0% | 46,000 | 2,367,342 | 6.58% |
The adjustment depends on whether the market will lift rents above passing. With flat rental values, the upward-only review on suite X never bites: 37.50 on the measured 23,800 sq ft is 892,500, below the 937,500 passing, so suite X keeps its rent and only the re-letting and the exit lose. The adjustment falls to 633,104, 1.76 per cent. Leases, review clauses and the rental outlook decide the number, which is why it cannot be a percentage of the price.
Real Estate Transaction Due Diligence sets technical, legal and financial findings against the price before signing, and the free workbook for this case attributes what each diligence workstream recovered.
It can renegotiate before exchange, and the measured survey is the evidence. The reduction should be what the smaller area does to value: on an illustrative 36,000,000 office measured at 47,600 sq ft instead of 50,000, re-running the cash flow gives 1,420,405, 3.95 per cent of the price.
Not under existing leases with a fixed rent, and an upward-only review cannot take it below the passing rent. The shortfall bites at reviews where market rent per square foot times the area exceeds passing, at re-lettings, and at exit. In the illustrative case the first rent difference appears in year 4, when one suite is re-let.
It usually overstates the loss for a let building, because contracted rent, and upward-only reviews where they bite, protect part of the income. On the illustrative office a pro rata cut is 1,728,000 against a cash flow answer of 1,420,405, 1.22 times. With flat rental values the cash flow answer falls to 633,104, 1.76 per cent of the price.
This article is one calculation from Real Estate Transaction Due Diligence. 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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