Real Estate, Commercial

How to Underwrite an Office Building

Underwrite an office building lease by lease: analyze each tenant's credit, remaining term and renewal probability, then model downtime, free rent and TI/LC costs at every rollover. The metrics that matter most are weighted average lease term, rollover concentration, re-leasing cost per square foot and debt yield on in-place NOI.

What makes office underwriting different

Office income comes from a small number of multi-year leases, so the underwriting is really a series of tenant credit decisions combined with a re-leasing forecast. A building can show strong current NOI while facing a cliff when its largest tenants expire. The biggest costs are not operating expenses but the capital needed to keep or replace tenants: tenant improvements, leasing commissions and free rent, which can consume several years of rent. Class, location, floor plate efficiency, parking and amenity package all influence how hard it will be to re-lease space in a market where tenants have choices and are often reducing footprint.

Lenders focus on downside cash flow: what NOI looks like if a major tenant leaves, how much rollover falls inside the loan term and whether reserves can fund re-leasing. They commonly use debt yield and in-place DSCR and often require TI/LC reserves and cash sweeps tied to lease events. Equity investors underwrite the opportunity in mark-to-market rents, repositioning and lease-up, accepting more vacancy risk for a lower basis. Many equity buyers today underwrite office on price per square foot relative to replacement cost and land value as much as on cap rate.

Key metrics

Weighted Average Lease Term (WALT)

Shows how long contracted income lasts. Short WALT relative to the loan term means the lender is underwriting re-leasing, not leases.

Lenders typically prefer WALT that meaningfully exceeds the loan term or a reserve plan covering the gap.

Lease Rollover Schedule

Concentrated expirations in a single year can drive a sharp NOI decline and refinancing failure.

Underwriters often flag any year where a large share of rentable area or base rent expires.

TI/LC per Square Foot

Tenant improvement and leasing commission costs determine how much capital each renewal or new lease consumes.

Debt Yield

For office, lenders lean on debt yield because cap rates and values have been volatile and less reliable.

Lenders commonly require low double digit debt yields on office, higher than for multifamily or industrial.

Tenant Credit Quality

A few tenants often provide most of the rent, so their financial strength drives default risk.

In-Place Rent vs Market Rent

Above-market leases will roll down at expiration, while below-market leases offer upside. This drives future NOI direction.

How to underwrite it, step by step

Abstract every lease for term, rent steps, options, termination rights, expense structure and co-tenancy clauses.
Assess the credit of the largest tenants using financial statements, ratings or payment history.
Build a rollover schedule and model renewal probability, downtime, free rent and TI/LC for each expiration.
Reconcile operating expenses and CAM recoveries, including base year and expense stop mechanics.
Confirm in-place rents against market comps and recent leasing at competing buildings.
Review building condition, systems, parking ratio and floor plate efficiency against tenant demand.
Size debt on in-place NOI using debt yield and DSCR, and test a downside where the largest tenant vacates.
Set TI/LC reserves, cash sweep triggers and lease approval rights in the term sheet.

Due diligence checklist

All leases, amendments and guaranties
Lease abstracts and current rent roll
Tenant estoppel certificates
SNDA agreements
Tenant financial statements for major tenants
T12 and CAM reconciliation history
Leasing commission agreements and outstanding obligations
Property condition report and ADA review
Market leasing comparables and broker opinion
Parking agreements and ratios
Phase I environmental site assessment
Appraisal with discounted cash flow

Key risks and mitigants

A major tenant vacates at expiration or exercises an early termination option.

Model the downside, require a cash sweep or lease-up reserve triggered by notice and size loan to post-vacancy coverage.

Re-leasing costs for TI, commissions and free rent exceed projections.

Use current market concession packages from broker surveys and fund upfront and ongoing TI/LC reserves.

Tenants reduce footprint at renewal.

Underwrite partial renewals, review tenant headcount and space utilization and stress occupancy.

Building becomes functionally obsolete relative to newer product.

Evaluate capital needed to compete, compare to replacement cost and include capex in the budget.

Above-market leases roll down at expiration.

Underwrite rollover at market rent and treat above-market income as temporary in valuation.

Typical financing and deal structure

Office is financed with bank loans, life company loans, CMBS and debt funds, with leverage generally more conservative than for other property types and heavily dependent on lease term and tenant credit. Lenders commonly require upfront and monthly TI/LC reserves, lockbox and cash management, and cash sweeps triggered by major tenant non-renewal, bankruptcy or a DSCR decline. Transitional or high-vacancy buildings often use floating rate bridge debt with future funding for leasing costs, sometimes with mezzanine debt or preferred equity filling the gap. Recapitalizations and discounted payoffs are common when existing loans exceed current value, and equity is often structured with sponsor co-investment and lender-approved leasing guidelines.

Red flags

One tenant pays a majority of base rent and its lease expires within the loan term.
Tenant estoppels reveal disputes, offsets or unrecorded amendments.
Large sublease availability from existing tenants in the building.
Early termination options exercisable before loan maturity without adequate fees.
Seller pro forma assumes lease-up at rents above recent comparable deals.

Frequently asked questions

How do lenders underwrite office buildings today?

Lenders focus heavily on in-place cash flow, tenant credit and lease expirations during the loan term. They typically size loans using debt yield and DSCR rather than relying on appraised value, require TI/LC reserves and impose cash sweeps if major tenants give notice. Loan-to-value is usually lower than for multifamily or industrial, and sponsor experience and liquidity carry significant weight.

What is WALT and why does it matter for office?

Weighted average lease term is the remaining term of all leases weighted by rent or square footage. For office, it shows how long contracted income lasts before the owner must re-lease space. A WALT shorter than the loan term means the lender is exposed to rollover, so lenders often require larger reserves or lower leverage for short-WALT buildings.

How do you model TI and leasing commissions?

For each lease expiration, estimate a renewal probability and blend renewal and new tenant assumptions. New leases typically carry higher tenant improvement allowances, full leasing commissions and longer free rent, while renewals cost less. Multiply per square foot costs by expiring area, place them in the year of rollover and deduct them below NOI to arrive at cash flow available for debt service.

What is the difference between Class A, B and C office?

Class A buildings are newer or fully renovated, with premium locations, amenities and institutional tenants. Class B buildings are older but functional with average finishes. Class C buildings are dated, often with deferred maintenance and lower-credit tenants. Underwriters generally apply higher vacancy, higher capex and wider cap rates as quality declines, and lender appetite drops sharply for Class C.

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Educational content, not investment, credit, legal or tax advice. Benchmarks are common practitioner rules of thumb and vary by lender, market and cycle.