Office Lease Economics: TIs, Free Rent, Effective Rent

Introduction

The $100-per-square-foot office lease is rarely a $100 lease. By the time you net out the months of free rent the landlord gives away at signing, the build-out budget it funds, and the commissions it pays the brokers, the rent that actually reaches net operating income on a typical Manhattan trophy deal sits closer to $72 per square foot. That gap, roughly a quarter to nearly a third of the headline number, is the entire subject of office lease economics, and it is the single most common place analysts get the office NOI story wrong.

The number that closes the gap is net effective rent: base rent stripped of the concession package over the full lease term. Three levers move it. Free rent abates the first several months of occupancy. Tenant improvement (TI) allowances fund the landlord's contribution to building out the space. Leasing commissions pay the brokers who source and negotiate the tenant. A headline rent that ignores any of these overstates the landlord's real economics, and on weaker assets the overstatement can be the difference between a lease that covers its capital cost and one that does not.

Every per-square-foot figure in office economics, including the TI allowances and effective rents below, rests on the rentable-SF denominator a tenant actually pays for, which is larger than the usable space it occupies. The load factor (also called the add-on factor) is the multiplier that converts usable square feet to rentable, capturing the tenant's pro-rata share of lobbies, corridors, and shared mechanical space:

A 15% load factor (a load factor of 1.15) means a tenant using 10,000 SF pays rent on 11,500. The complement is the loss factor, the share of rentable area the tenant never occupies, which equals (Rentable SF minus Usable SF) divided by Rentable SF; on that same lease it works out to about 13%. Because face rent is quoted on rentable SF, a higher load factor lifts the effective cost of the usable space the tenant actually works in.

Concession packages had widened every year since the pandemic until full-year 2024, when they compressed for the first time in four years. National TI allowances fell to $87.51 per square foot from $97.55 in 2023, and blended free rent dropped to 8.9 months from a 9.6-month peak, according to CBRE's analysis of 4,350 new office leases across 12 US markets from 2019 to 2024. Even after the compression, concessions ran roughly 30% above pre-pandemic norms, so the headline-to-effective gap remains wide and worth modeling carefully.

The national average masks a wide spread. Build-out costs are local, tenant demand is local, and trophy demand diverges sharply from commodity demand, so the TI a landlord must fund to win a deal ranges from the $60s in Sun Belt secondary CBDs to well past $130 in gateway trophy submarkets. The figures below are indicative new-lease Class A levels, not renewals.

The bigger swing is new lease versus renewal. A new lease starts from a shell or a stripped prior tenant's space and the landlord funds a full build-out; a renewal keeps a tenant who is already fitted out, so the allowance covers only a refresh. The convention puts new-lease TIs at roughly 2 to 3 times renewal TIs on the same space. Renewal allowances (often called refresh allowances) typically run $15 to $40 per SF, enough to update finishes and amenities without reconstruction. The same divergence shows up in the Manhattan data: 2024 new-deal TIs stabilized near $132 per SF while renewal TIs averaged closer to $89 per SF.

The flight-to-quality split also widened the band within each market. Through 2024, lower-tier TIs fell roughly 16% to about $73 per SF nationally while top-tier TIs fell about 10% to roughly $92 per SF: weaker buildings cut harder because they had less pricing power, not because they needed to spend less to win tenants.

Free rent abates the first months of occupancy, and it scales directly with the base rent it suspends, so a month of free rent on a $100 lease costs the landlord far more than a month on a $45 lease. Trophy landlords give away less of it because demand is stronger and their leverage is greater; commodity submarkets give away more to fill space. The blended national figure fell to 8.9 months in full-year 2024 from a 9.6-month peak, though the gateway top of the market still ran far higher: among Manhattan's ten largest 2024 leases, free-rent periods stretched past 14 months.

Net effective rent collapses all three levers into one number, the landlord's average economic rent across the full term:

The concession total is itself a sum of the three levers, which is worth writing out because it is where the arithmetic usually goes wrong:

Leasing commissions typically run 4% to 6% of total lease value on a new lease, split between the tenant rep and the landlord broker. Net the three against gross rent, divide by the term, and the result is the rent the asset actually earns.

It is worth tracking the two largest concession items as intensity ratios, because they reveal how expensive a lease is to win independent of its size. TI per SF normalizes the build-out cost across deals of different footprints, and leasing commissions are most usefully read as a percentage of the lease value they are paid against:

Together these quantify leasing-cost intensity: a high TI per SF and a high LC percentage mean the landlord is spending heavily to capture each square foot of rent, which is exactly the cost a renewal lets it avoid.

The same arithmetic that trims a quarter off a trophy lease can break a Class B lease outright. Lower base rent generates less gross rent to absorb the concession package, yet the build-out a tenant demands does not shrink proportionally, so a Class B landlord ends up funding a near-trophy concession out of a far smaller rent stream. The numbers tell the story directly: a Class B landlord offering $70/SF TI and 12 months free rent on a 7-year lease at $45/SF face rent lands at an effective rent in the $26 to $29/SF range, well over a third below the quoted figure and often below the all-in cost of carrying and re-leasing the space.

The flight to quality compounds it. Through 2024, lower-tier concessions ratcheted up faster than top-tier as weaker buildings chased thinning demand, even as their headline rents fell. The divergence runs all the way to net effective rent: top-tier effective rents rose roughly 5.2% over the year while lower-tier effective rents fell, partly because top-tier landlords could cut concessions and raise base rent at the same time and lower-tier landlords could do neither.

The new-versus-renewal split is the most reliable place to add value in office leasing, and it is invisible if you only read the face rent. A new lease carries the full acquisition cost: the higher TI to build out from shell, the longer free rent to lure a tenant across the market, the full broker commission. A renewal keeps a tenant who is already in place and already fitted out, so it carries a refresh-level TI of $15 to $40 per SF, often only a month or two of free rent, and a reduced or zero broker fee.

Net Effective Rent (Office)

The landlord's average economic rent across the full lease term after subtracting the concession package (free rent, the tenant improvement allowance, and leasing commissions) from gross base rent, then dividing by the term. It runs materially below headline base rent on most modern office leases, typically a quarter to nearly a third below on large Class A deals, and it is the rent figure that flows into NOI and into asset valuation. Headline-rent comparisons that ignore concessions systematically overstate the economics.

Run two otherwise identical leases at the same $100 face rent, one new and one a renewal, and the renewal lands roughly 15 to 20 percentage points higher in effective rent purely because it absorbs less concession. That spread is why office landlords spend on amenities, building services, and proactive lease management to keep tenants in place: retaining a tenant is worth far more than the face rent suggests, because it sidesteps the concession reset a new lease would trigger. The metric that captures how well a landlord avoids that reset is tenant retention, the share of expiring space that renews rather than vacating:

A high retention rate is worth more than the headline rents alone imply, precisely because every renewed square foot dodges the full new-lease concession package (the higher build-out TI, the longer free rent, and the full broker commission) modeled throughout this article. The same logic governs the broader commercial lease mechanics that apply across property types, and it feeds directly into how property-level cash flows get valued in a transaction.