Why Leasing Assumptions Carry More Weight Than the Cap Rate
Every acquisition model tells a story, and the leasing assumptions are the plot. The cap rate on the cover sheet is a conclusion drawn from dozens of inputs the market never sees, and the most consequential of those inputs are the forward-looking expectations embedded in market leasing assumptions. Getting those assumptions wrong — even slightly, even honestly — can turn a projected 7 percent return into a realized 4 percent, or worse.
7 Market Leasing Assumptions That Shape an Acquisition Model
The phrase "7 Market Leasing Assumptions That Shape an Acquisition Model" describes a framework practitioners use to pressure-test the rent roll before capital is committed. The seven assumptions covered here represent the full economic story of a lease: what space costs, how long it stays vacant, how much it costs to place a tenant, and how that cycle repeats across the hold period.
Assumption One — Market Rent at the Time of Lease Commencement
Market rent is the starting point for every lease economics calculation in an acquisition model. It drives base revenue projections, it anchors rent bumps, and it sets the floor for reversion analysis at disposition. Getting it right requires more than pulling the asking rent on CoStar — it means triangulating executed lease comparables, adjusting for concession packages, and understanding where the submarket sits in its own supply cycle.
Executed rents and asking rents regularly diverge by meaningful amounts, particularly in markets with high concessions or landlord-favorable conditions. A building with $55 asking rent may be clearing leases at $48 effective when free-rent periods and tenant improvement packages are taken into account. The acquisition model should use the executed, net-effective rent as the market assumption, not the marketed rate.
Submarket dynamics add another layer. If comparable buildings have absorbed space rapidly and new supply is two or more years away, a slight premium to recent comps may be defensible. If supply pipelines are active and tenant demand is softening, the assumption should carry a modest discount to protect the downside scenario. Underwriters who build the market rent assumption from the inside out — submarket vacancy, pipeline, and comparable execution — produce models that hold up under lender scrutiny.
Assumption Two — Lease Term
Lease term shapes the timing of every other leasing assumption. A 10-year base term compounds rent bumps longer, defers re-leasing costs further into the hold, and produces a different reversion cap rate story than a 5-year term. The right assumption depends on the tenant profile, the building class, and what the market is actually signing.
Credit tenants in institutional-grade buildings regularly sign 10- to 15-year terms when market conditions favor it. Smaller tenants in mid-market buildings often sign 3- to 5-year terms, sometimes with renewal options that the acquisition model must handle carefully — options are tenant rights, not landlord certainties. The model should assume that renewal options are exercised only when it is economically rational for the tenant, not as a default revenue line.
For a 10-year hold, a building populated with 5-year leases means the entire rent roll turns over at least once inside the hold, triggering every leasing cost assumption again. That second cycle dramatically affects the internal rate of return. Underwriters should run a scenario in which short-term leases do not renew and the building absorbs at a measured pace, to understand the IRR sensitivity before pricing the asset.
Assumption Three — Rent Growth Rate
Rent growth assumptions are where optimism most often enters the model unchecked. A 3 percent annual escalation applied to a $50 per square foot base rent adds meaningful revenue over a 10-year hold, and small changes in this assumption produce large swings in terminal value. The question is whether 3 percent reflects the market's historical rent trajectory or a projection based on current enthusiasm.
Long-term rent growth in most commercial submarkets has averaged somewhere between CPI and CPI plus a modest premium, though that figure varies widely by asset class and geography. Industrial markets in logistics corridors have produced exceptional rent growth over the past decade. Office markets in areas with elevated remote-work adoption have produced negative real rent growth in many cases. The assumption should be anchored to the specific submarket, not to asset-class headlines.
Stress-testing rent growth is as important as selecting the base assumption. A scenario with flat real rent growth — nominal growth matched to inflation — alongside the base case gives the investment committee a credible downside. A scenario with a single rent correction cycle, common in markets tied to single-employer demand, tests the asset's resilience further. Models that only carry upward rent paths are advocacy documents, not underwriting tools.
Assumption Four — Free Rent Period
Free rent is a direct cost that reduces effective rent and reduces yield from day one of a lease. Acquisition models frequently understate the free rent assumption because comps are hard to verify and landlords marketing assets prefer to emphasize the face rent. The discipline is to find executed leases in the submarket and document what free rent tenants actually received, not what landlords advertised they were offering.
In markets where tenant leverage is high, six to twelve months of free rent on a 10-year lease is not unusual. Even three months of free rent on a 5-year lease reduces the effective rent by 5 percent. When this is applied across a multi-tenant rent roll, the cumulative impact on NOI is substantial. The acquisition model should represent free rent period as a negative cash flow item in the year it occurs rather than amortizing it invisibly across the full term.
The free rent assumption also interacts with the lease-up timeline for vacant space. If a building has 20 percent vacancy at acquisition and the model projects leasing that space in year one, the free rent period means that cash flow from that space may not commence until year two. Building the free rent period explicitly into the leasing timeline prevents the model from overstating early-year cash flows — a common underwriting error that lenders will identify in their own review.
Assumption Five — Tenant Improvement Allowance
Tenant improvement allowance is the largest single capital outlay in most leasing scenarios, and it is the assumption most likely to be optimistic in an acquisition model. A new lease in a Class A office building may require $60 to $100 or more per square foot of tenant improvements in markets with elevated build-out expectations, though actual figures vary by market, building condition, and tenant profile. Renewal leases typically carry lower TI requirements, but not zero — tenants use renewal negotiations to extract refreshes and reconfigurations.
The model should distinguish between new leases and renewals and assign realistic TI assumptions to each. Using a blended average across both produces a number that overstates renewal economics and understates new lease costs. Where the rent roll contains significant near-term lease expirations, the model should identify which of those tenants are likely to renew and which are likely to vacate, and apply the appropriate TI assumption to each scenario.
TI allowances are often presented as a capital expenditure at lease commencement, but their economic impact is felt immediately in cash flow. The acquisition model's IRR calculation should capture TI as a true outflow in the year the lease is executed, not as an amortized cost spread across the lease term. Some sellers present models that amortize TI costs to inflate near-term cash flow; buyers and their advisers should normalize this before pricing.
Assumption Six — Leasing Commissions
Leasing commissions are negotiated between landlords and tenant representatives and vary by market convention, tenant size, and transaction structure. In many markets, total commissions on a new lease — split between the listing broker and the tenant-rep broker — range from one to three months of base rent per year of lease term, though market conventions differ and local comps should govern the assumption. Renewal commissions are typically lower but should not be assumed to be zero without evidence.
The acquisition model should capture leasing commissions as a cash outflow in the year of lease execution, consistent with how TI allowances are treated. Staggering the leasing timeline across the hold period distributes these costs realistically; assuming all leases are signed in a single year concentrates costs artificially and distorts the IRR. For multi-tenant properties, the leasing schedule should reflect realistic absorption — typically measured in square feet per quarter at the market's historical pace.
Leasing commissions on renewal leases are sometimes omitted from models when the seller wants to present renewals as low-cost events. A renewal that requires no commission is the exception rather than the norm in most professionally managed markets. The underwriting assumption should include a commission consistent with market practice for renewals, even if it is lower than a new-lease rate, to avoid building a false floor into the renewal economics.
Assumption Seven — Downtime Between Leases
Downtime — the period between lease expiration and the commencement of the successor lease — is perhaps the most underappreciated assumption in an acquisition model. During downtime, the space generates no revenue, operating expenses continue, and the landlord is absorbing the cost of vacancy alongside the cost of re-leasing. Even a few months of additional downtime compounded across multiple lease events can reduce the IRR by a material amount.
Downtime assumptions should be drawn from submarket absorption data and comparable transaction history. A market where tenant demand is active and similar space has been absorbed quickly may justify a downtime assumption of three to six months. A market with elevated vacancy or where the subject building's space type is out of favor may require nine to eighteen months of downtime, or more. The assumption should reflect current market conditions, not the most optimistic recent comp.
The interaction between downtime and free rent is worth modeling explicitly. If downtime is six months and the successor lease carries six months of free rent, the effective cash flow gap from lease expiration to first rent collection is twelve months. On a large block of space, that is a significant drag on IRR. Models that separate downtime and free rent into distinct line items — rather than blending them into a single vacancy reserve — produce clearer visibility into the total lease-transition cost and make the assumption easier to audit and defend.
How These Seven Assumptions Interact in the Model
The seven assumptions do not operate independently — they form a chain. Market rent determines the starting point for rent growth, which compounds over the lease term and sets the reversion rent at disposition. Free rent reduces the first year's effective cash flow from each new lease. TI allowances and leasing commissions create capital outflows at lease commencement. Downtime creates gaps in revenue between lease events. When a model carries optimistic values on even three of these seven assumptions, the cumulative effect on projected NOI and IRR can be dramatic.
The right way to evaluate any acquisition model is to isolate each assumption and ask: where did this number come from, and how does the asset perform if this assumption is 10 or 20 percent more conservative? A model that holds its return at an acceptable level under moderate stress across all seven assumptions is a credible underwriting. A model that requires all seven assumptions to perform at the optimistic end simultaneously to clear the hurdle rate is a risk the investment committee should understand explicitly before voting.
Building a sensitivity matrix around lease-economics assumptions — with market rent on one axis and downtime or TI on another — gives decision-makers a visual representation of the range of outcomes without requiring them to read the full model. Advisers who present acquisitions with this level of stress-testing transparency are more likely to gain committee confidence and are better positioned to defend the underwriting if conditions change post-closing.
Tools and Workflows That Support Assumption-Building
The quality of these seven assumptions depends entirely on the quality of the market research and comparable analysis behind them. Pulling comps from a single source, without reviewing the lease documents or confirming execution details, produces assumptions that may feel precise but are actually loosely grounded. The discipline of comp verification — confirming tenant, term, rent, TI, free rent, and commission from reliable sources — is what separates a defensible model from a litigable one.
Stress-Testing the Assumption Set Before Committee
Before any acquisition goes to committee, the leasing assumptions should be formally stress-tested against three scenarios: a base case that reflects the market's most likely outcome, a downside case that applies conservative values to market rent, downtime, and TI simultaneously, and an extended downside that models a leasing market correction occurring in year two or three of the hold. Presenting all three scenarios with the same level of financial detail as the base case demonstrates that the adviser team has genuinely tested the thesis, not just validated it.
The base case should not be the most optimistic scenario — it should represent the median expected outcome given current market data. Many acquisition models that reach committee carry base-case assumptions that are closer to an upside scenario, creating an implicit over-promise that surfaces when the asset performs to actual market conditions. Disciplined underwriters set the base case conservatively and let the upside scenario represent the aspiration rather than the expectation.
Lenders conducting their own underwriting will apply a haircut to market rent assumptions and extend downtime beyond the borrower's projection. A borrower who arrives at the lender with a completed stress-test covering the same ground — and who can show the assumption documentation behind each scenario — accelerates the lender's diligence process and demonstrates underwriting credibility. The underwriting package should include the assumption documentation as a standalone exhibit, not embedded invisibly inside the model.
Why the Disposition Cap Rate and Market Assumptions Are Linked
The terminal value of a commercial real estate acquisition is typically calculated by applying a reversion cap rate to the projected net operating income in the sale year. That projected NOI is a direct function of the leasing assumptions embedded in the hold-period model — particularly market rent, rent growth, and downtime in the final lease cycle. If the leasing assumptions are optimistic, the terminal value is doubly optimistic: it assumes elevated NOI and applies a cap rate to that elevated base.
This compounding effect means that leasing assumption errors are amplified at disposition. A market rent assumption 10 percent above what the market will actually support, combined with a reversion cap rate that assumes continued favorable conditions, can produce a terminal value that is 20 to 25 percent above what a buyer will actually pay. When the disposition falls short, the IRR impact is severe because terminal value represents the largest single cash flow in most hold-period models.
The discipline of anchoring the reversion cap rate to a realistic long-term market assumption — rather than current market conditions, which may reflect peak pricing — is well understood in acquisition underwriting. Less often discussed is the equal importance of anchoring the reversion NOI to realistic leasing assumptions in the final years of the hold. Both inputs deserve the same scrutiny.
Site Selection, Portfolio Context, and Acquisition Modeling
The seven leasing assumptions described here apply most directly to income-producing acquisitions, but they also appear in occupier decisions — sale-leaseback transactions, build-to-suit evaluations, and long-term lease-versus-buy analyses. In those contexts, the buyer is both the landlord and the tenant, and the leasing assumptions describe the economics of the organization's own occupancy cost over time.
A lease signed at above-market rent in a softening market becomes an economic liability; a lease signed at below-market rent in a tightening market becomes a hidden asset.
Occupier teams evaluating whether to renew, relocate, or purchase also benefit from a disciplined approach to the same seven assumptions. The lease economics of a renewal — including the free rent, TI, and term the landlord will offer — should be compared against the economics of a new location using consistent assumptions. When renewal economics and relocation economics are evaluated with the same framework, the comparison is legitimate. When they are evaluated with different standards, the organization risks making a decision that looks favorable on paper but underperforms in practice.
That consistency is what makes the comparison defensible when it reaches decision-makers.
Pulling the Framework Together
The seven assumptions reviewed here — market rent, lease term, rent growth, free rent, tenant improvement allowance, leasing commissions, and downtime — are individually familiar to any experienced underwriter. What matters is treating them as an integrated set rather than independent inputs. Each assumption affects the others, and the cumulative error from carrying optimistic values across the full set is far larger than any single assumption error in isolation.
The practical discipline is straightforward: document the source of every assumption, run a credible downside that stresses all seven simultaneously, and present the full scenario set to whoever is making or approving the capital decision. Acquisition underwriting that meets this standard produces decisions that hold up — in committee, in lender review, and in realized performance over the hold period.
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