The Renewal Offer That Loses Money
A 45,000 sq ft suburban office building has one tenant occupying 18,000 sq ft at $24/sq ft gross, with 14 months remaining. The tenant asks for a five-year renewal at $22/sq ft gross with $60,000 of landlord-funded improvements and six months of free rent. Market rent is $25/sq ft gross, but vacancy in the submarket is 19% and has been rising for six quarters. Releasing the space would cost $8/sq ft in leasing commissions, $35/sq ft in tenant improvements, and an estimated 11 months of downtime at current absorption. Operating expenses are $9.50/sq ft and rising 4% annually. The owner wants to know whether to accept, counter, or let the tenant walk.
1. Compare the net effective cost of the renewal offer against the cost of releasing the space.
Read the worked answer
Renewal: five years at $22 gross on 18,000 sq ft = $1,980,000 of base rent. Subtract $60,000 TI and six months free rent (18,000 × $22 × 0.5 = $198,000), giving net rent of $1,722,000 over five years, or $344,400/year - about $19.13/sq ft net effective. Landlord costs are $258,000.
Release: assume the space re-lets at market $25 gross after 11 months of downtime. Over the same five-year window you lose 11 months of rent (18,000 × $25 × 11/12 ≈ $412,500), plus commissions (18,000 × $8 = $144,000) and TI (18,000 × $35 = $630,000) - total frictional cost about $1,186,500 before you collect a dollar. Even at the higher $25 face rate, the release path nets roughly $25 × 18,000 × 4.08 years ≈ $1,836,000 minus $1,186,500 ≈ $650,000 over the comparable period, versus $1,722,000 for the renewal.
The renewal is clearly superior on net effective economics. The $22 face rate is a distraction; the comparison is net of downtime and frictional cost, and the renewal wins by a wide margin in a 19%-vacancy market.
2. The owner insists $22 is below market and wants a counter. Draft the counter strategy and the concessions you would trade.
Read the worked answer
Counter at $23.50 gross with a phased concession package, and be explicit that you are trading face rate for term and certainty.
Structure: $23.50 in year one, escalating 3% annually to $26.41 by year five - that gets the owner above today's $25 market by year three and protects against the 4% expense growth, which at $9.50 and rising is eroding the gross margin every year. Reduce free rent from six months to three, and tie the TI to a disbursement schedule paid after rent commencement, not before. Offer a renewal option at year five at 95% of fair market value rather than a fixed number, so the owner is not locked below a recovering market.
Trade list: give the tenant the TI and a modest free-rent period; hold firm on term length and on a gross-up/expense-stop provision so the owner is not absorbing 4% annual expense growth for five years. If the tenant will not move off $22, accept only with an expense stop - a $22 gross lease with no stop in a 4%-growth expense environment could easily net below $12/sq ft by year five.
Do not let the tenant walk over $1.50. The release math shows the walk costs far more than the concession.