An office deal can look attractive on a trailing operating statement and still be a poor acquisition. A building with 85% occupancy may have one major tenant leaving next year, below-market lease rates that require expensive renewals, or a capital plan the seller has not fully disclosed. Knowing how to underwrite office buildings means translating those details into a realistic view of cash flow, risk, and value.
Office underwriting is less about finding one perfect cap rate and more about building a defensible story behind the numbers. Your assumptions should explain what happens as leases roll, tenants make decisions, and the property competes for occupancy in its submarket.
Start With the Office Asset, Not the Spreadsheet
Before modeling revenue, identify what you are actually buying. Office properties do not compete in one broad category. A renovated medical office building, a suburban Class B multi-tenant asset, and a downtown Class A tower have different tenant pools, leasing costs, demand drivers, and downside risks.
Review the property’s location, building class, age, access, parking ratio, floor plate size, amenities, condition, and recent capital improvements. Then compare those characteristics with the tenants the building needs to attract. A property with large floor plates may work well for a headquarters user but be difficult to lease to smaller professional-service tenants. A dated building may retain occupancy only by offering lower rents or larger concessions.
The question is not simply whether the building is occupied today. Ask whether it is positioned to remain competitive through your hold period.
Build Revenue From the Rent Roll and Lease Abstracts
The rent roll is the starting point, not the final answer. Reconcile it to lease abstracts and review every meaningful tenant lease. Focus on suite size, in-place rent, lease expiration, renewal options, expense reimbursements, rent escalations, free-rent periods, tenant improvement obligations, and termination rights.
For each tenant, compare the contractual rent with market rent. If in-place rent is above market, a lease expiration may create a revenue decline even if the tenant renews. If rent is below market, do not automatically mark it up at expiration. The tenant may have negotiated a lower rate because of condition, vacancy in the submarket, or a concession package that a headline rent figure does not show.
Measure Lease Rollover Risk
Create a lease-expiration schedule by year and by square footage. Then identify tenant concentration. A 40,000-square-foot tenant occupying 35% of a building can dominate the investment outcome, especially if its lease ends early in the hold period.
A useful underwriting case separates rollover into three possibilities: renewal, replacement, and vacancy. For a renewing tenant, model a realistic renewal probability, market rent, downtime if applicable, tenant improvements, leasing commissions, and free rent. For a departing tenant, model vacancy from the expiration date through expected lease-up, followed by new-tenant costs.
Do not assume every expiring suite rolls immediately into a new lease. In a soft office market, leasing a vacant floor may take 12 months or longer. The appropriate downtime depends on suite size, location, configuration, asking rents, and current market availability.
Underwrite Physical and Economic Occupancy Separately
Physical occupancy measures leased space. Economic occupancy measures the revenue actually collected. Both matter. A building can be physically occupied but economically weak because of free rent, delinquency, below-market leases, or uncollected reimbursements.
Model base rent by tenant and month when the deal warrants it. A monthly schedule makes free-rent periods, step-ups, expirations, and new leases visible. Annual modeling can work for stabilized, low-rollover assets, but it can hide risk in a transitional office deal.
Normalize Operating Expenses and Recoveries
Office leases often shift some expenses to tenants, but reimbursement structures vary widely. Gross leases, modified gross leases, triple-net leases, base-year stops, and expense caps produce different owner exposure. You cannot underwrite expenses correctly without understanding who pays what.
Start with historical operating statements, preferably three years, and compare them to the current budget. Separate controllable expenses from fixed or less controllable items. Real estate taxes, insurance, utilities, repairs and maintenance, janitorial, security, management, landscaping, elevator service, and administrative costs all deserve review.
For expense recoveries, test the lease language rather than accepting a single recovery line from the seller. Confirm each tenant’s base year, expense stop, gross-up methodology, exclusions, caps, and audit rights. A property may appear to recover 90% of expenses on paper while actual lease provisions leave the owner responsible for substantial increases.
Use market-informed growth assumptions. Insurance and taxes may rise faster than general inflation, particularly after reassessments, claims activity, or changes in local tax rules. If a seller’s trailing expenses are unusually low, find out whether the property has deferred maintenance, an expiring vendor contract, or an owner-managed cost that will increase after closing.
Model Capital Needs and Leasing Costs Honestly
Office cash flow is often distorted when tenant improvements and leasing commissions are treated as occasional surprises instead of recurring ownership costs. They are part of the business plan.
Estimate tenant improvements and commissions separately for renewals and new leases. New tenants typically require more capital than renewals, but the right assumptions depend on market, tenant type, building class, and suite condition. Legal fees, moving allowances, demolition, design costs, and free rent can also be material.
Review the property condition report, roof age, HVAC inventory, elevator records, facade condition, parking lot condition, and life-safety systems. Distinguish between recurring replacement reserves and specific near-term capital projects. A reserve may cover ordinary wear, but it will not solve a $1 million HVAC replacement program.
When a seller says the asset is “turnkey,” confirm what has actually been replaced, when it was replaced, and whether warranties transfer.
Determine Value Through Multiple Lenses
A direct capitalization approach remains useful, but only when the net operating income is stabilized and credible. For an office building with near-term rollover, the trailing NOI may not represent the income an investor can expect after lease costs and vacancy.
Calculate value using stabilized NOI and a market-supported cap rate, then compare that result with a discounted cash flow analysis. Your DCF should reflect the timing of vacancy, lease-up, rent growth, operating expenses, capital expenditures, and a terminal value at sale. The exit cap rate should generally be more conservative than the going-in cap rate when the market is uncertain or the building faces meaningful future rollover.
Also calculate value per square foot and compare it with recent, relevant sales. This does not replace income-based valuation, but it can reveal when a projected value requires an unusually aggressive rent assumption or cap rate.
Stress Test the Debt and the Business Plan
Debt can make an office investment appear stronger than it is. Model the actual loan terms, including interest rate, amortization, interest-only period, lender reserves, extension options, prepayment costs, and maturity date. Then test debt service coverage and debt yield under both in-place and stressed cash flow.
At a minimum, pressure test several variables together rather than one at a time:
- Longer downtime before vacant suites are leased
- Lower renewal probability or lower renewal rent
- Higher tenant improvements, commissions, and free rent
- Faster growth in taxes, insurance, or utilities
- A higher exit cap rate and lower sale price
The goal is not to make every deal fail. It is to identify what must go right for the investment to meet its return target. If a modest leasing delay causes a cash shortfall, the deal may need more equity, better loan terms, a lower purchase price, or a different business plan.
Turn Assumptions Into an Investment Decision
A clear office underwriting model should show the investment committee, lender, partner, or client where returns come from and where they could break. Document the source of each major assumption: lease documents, historical financials, broker guidance, market data, property inspections, or your own judgment.
Keep the base case realistic, not optimistic. Then use upside and downside cases to frame the range of outcomes. This approach is especially valuable for brokers who need to explain viability to clients and investors who need to protect credibility when discussing projected returns.
Good office underwriting does not eliminate uncertainty. It gives uncertainty a place in the model, assigns it a cost, and helps you decide whether the price compensates you for taking it on. That is the confidence worth carrying into a negotiation.
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