A lease expiry is a dated, lumpy cost: price the void, the empty-property costs and the fees, weight them by the chance the tenant stays, and put the result in the year it lands.
Add the rent lost during the void, the landlord's empty-property costs, and the letting and legal fees, then weight the re-letting cost against the cheaper renewal by the chance the tenant stays. On an illustrative unit with a rental value of 500,000, a nine-month void costs 502,500, about 12.1 months of rent; at a 60 per cent renewal probability the expected cost of the expiry is 285,000, or 6.8 months.
Worked in full in Commercial Real Estate Investing by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Most cash flow models handle lease expiries with a general vacancy deduction of a few per cent a year. That spreads a lumpy, dated cost evenly across the hold, which is wrong for valuation, wrong for the debt covenant in the year it lands and wrong for the IRR if the expiry falls near the sale. The calculation below prices one expiry properly, then shows how far a flat allowance misses it.
| Input | Value |
|---|---|
| Passing rent on the expiring lease | 450,000 |
| Rental value (ERV) for a new letting | 500,000 |
| Void if the tenant leaves | 9 months |
| Empty-property costs: rates, service charge shortfall, insurance, a year | 90,000 |
| Letting agent's fee, share of the new annual rent | 10% |
| Legal costs on a new letting | 10,000 |
| Renewal: rent-free incentive / fees | 3 months / 15,000 |
| Probability the tenant renews | 60% |
The void follows the convention used in the companion income model: a lease that expires at the end of year e pays its old rent through year e, and the year after collects only three twelfths of the new rent, 125,000 here. All figures are illustrative and the benchmark for "lost" rent is an uninterrupted letting at the 500,000 rental value.
Re-letting cost = ERV × void/12 + empty costs × void/12 + fee rate × ERV + legal
Renewal cost = ERV × rent-free/12 + renewal fees
Expected cost = p × renewal cost + (1 − p) × re-letting cost
In Excel: =p*(ERV*RF/12+RenFees)+(1-p)*(ERV*Void/12+Empty*Void/12+Fee*ERV+Legal).
| Item | Tenant leaves | Tenant renews |
|---|---|---|
| Rent lost (void or rent-free) | 375,000 | 125,000 |
| Empty-property costs | 67,500 | |
| Letting fee | 50,000 | |
| Legal and renewal fees | 10,000 | 15,000 |
| Total cost | 502,500 | 140,000 |
If the tenant leaves, the cost is 502,500: 12.1 months of the new rent, or 1.12 years of the rent the old tenant was paying. Nine months of void costs a full year once the landlord's own costs and fees are counted, and the empty-property costs are the line most often missed, because they are not rent and do not appear in the rent roll.
Weighting the outcomes, 60 per cent of 140,000 is 84,000 and 40 per cent of 502,500 is 201,000. The expected cost of the expiry is 285,000, 6.8 months of rent. That is the figure to deduct from the year after expiry in a probability-weighted cash flow, and the figure an asset manager should compare with the cost of a deal to keep the tenant early: a deal that makes the renewal certain is worth up to 145,000 on top of the standard renewal terms, the expected 285,000 less the 140,000 a renewal costs anyway. The trade-off between a lower rent now and a higher rent later uses the same arithmetic.
| Void | Re-letting cost | Renewal 40% | Renewal 60% | Renewal 80% |
|---|---|---|---|---|
| 3 months | 207,500 | 180,500 | 167,000 | 153,500 |
| 6 months | 355,000 | 269,000 | 226,000 | 183,000 |
| 9 months | 502,500 | 357,500 | 285,000 | 212,500 |
| 12 months | 650,000 | 446,000 | 344,000 | 242,000 |
Each extra quarter of void adds 147,500 to the cost of a departure. The renewal probability matters most when voids are long: at twelve months, moving from 40 to 80 per cent renewal cuts the expected cost by almost half, from 446,000 to 242,000. In a weak letting market both inputs worsen together, which is why a building with a heavy expiry year is riskier than its average vacancy suggests. The WAULT to expiry and to break tells you when those years fall.
A 5 per cent general vacancy deduction on the 450,000 passing rent takes 22,500 a year, 225,000 over a ten-year hold. In total, undiscounted, that is not far from the expected cost. In timing it is far off. In the year after a departure, a model with the flat allowance shows 475,000 of income from the unit, the 500,000 new rent less 5 per cent. The actual cash is three months of new rent less nine months of empty costs, the letting fee and legal costs: minus 2,500. For a lender testing cover in that year, or a buyer pricing the asset on that year's income, the difference is the whole unit.
Price each expiry as a dated event: 502,500 if the tenant goes, 140,000 if it stays, 285,000 expected at a 60 per cent renewal chance. Put it in the year it lands, not spread across the hold. The income model in the free workbooks for this case applies the same re-letting rule to every unit on the rent roll and costs each one in cash.
It depends on the market, the building and the unit, so model a range. On the illustrative 500,000 unit, each quarter of void adds 147,500 to the cost of a departure: 207,500 at three months, 355,000 at six, 502,500 at nine and 650,000 at twelve, once empty-property costs and fees are included.
Not for a building with identifiable expiries. A 5 per cent allowance on 450,000 of passing rent takes 22,500 a year, and in the year after expiry the same 5 per cent on the 500,000 new rent still shows 475,000 of income, when the actual cash from the unit after a nine-month void, empty costs and fees is minus 2,500.
Compare the incentive with what it saves. On the illustrative unit, a departure costs 502,500 and a renewal with three months rent-free costs 140,000, a gap of 362,500. Each point of renewal probability is therefore worth 3,625, and an incentive that lifts the chance of renewal from 60 to 80 per cent is worth paying if it costs less than 72,500.
The income account with the void applied is built in chapters 1 to 4 of Commercial Real Estate Investing. 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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