A renewal-versus-replacement model compares the owner’s full cash flow from keeping a tenant with the full cash flow from re-leasing the premises. Use the same starting date, investment horizon, area, expense basis, and residual-value method. Include downtime, free rent, tenant improvements, commissions, building work, tenant credit, and funding—not merely the two face rents.
The decision may favor a lower-rent renewal when it preserves cash and avoids substantial capital. It may favor replacement when a stronger tenant, better use, longer term, or higher supported economics compensate for cost and risk. The model should explain that tradeoff in numbers the owner can fund.
Begin before the existing lease expires
Establish the current tenant’s remaining rights, option dates, proposed renewal terms, and expected surrender condition. Confirm what the owner can actually choose. A valid tenant renewal option may constrain the alternatives; counsel should interpret the agreement.
Obtain realistic replacement evidence: competing suites, prospective users, contractor scope, delivery timeline, and brokerage terms. A theoretical higher market rent is not an executable replacement proposal. Mark unsupported assumptions visibly.
Use current local evidence for a Chicago-area asset rather than copy national or coastal office averages. Public REIT filings can clarify categories and risks, but their portfolio costs are not quotes for the subject suite.
Set a common decision horizon
Suppose the owner expects to hold for five more years. A renewal starts immediately, while a replacement begins after nine months. Compare both over those same sixty months. Do not give the replacement sixty full rent-paying months while giving the renewal only the actual hold period.
At the end of the model, value the remaining lease and physical property consistently. A replacement might have more term left at sale, which can be valuable; it might also carry future obligations. Capture that in the residual assumption rather than silently extending one case.
Use monthly cash flows where timing matters. Annual averages can hide initial deficits and the difference between construction, free rent, and paying occupancy.
Hypothetical five-year comparison
Assume a 5,000-square-foot suite. The renewal starts immediately at $28 per square foot annually, with flat rent, $50,000 TI, and $20,000 commission. The replacement offers $32 per square foot, begins after nine months of vacancy, and receives three more months of free base rent. Replacement TI is $200,000, commission $40,000, and vacant carry $4,000 monthly for nine months.
Ignore recoveries and other operating expenses initially and assume the comparison horizon is sixty months from today.
| Item | Renewal | Replacement |
|---|---|---|
| Annual face rent | $140,000 | $160,000 |
| Paying months within hold | 60 | 48 |
| Base rent received | $700,000 | $640,000 |
| TI | ($50,000) | ($200,000) |
| Commission | ($20,000) | ($40,000) |
| Vacant carry | $0 | ($36,000) |
| Illustrative net before other costs and residual | $630,000 | $364,000 |
Replacement’s $4 higher face rent produces $266,000 less under these assumptions. That is not the final investment conclusion because expense recovery, credit, residual value, and other costs remain to be added. It is enough to show why a higher quoted rate cannot decide the question.
The replacement’s three free months are already excluded from its 48 paying months. Do not subtract the same free rent again as a separate cash expense.
Support new and renewal costs independently
Existing improvements can make a renewal cheaper, but the tenant may still require meaningful work. A replacement may reuse the layout, or it may need complete demolition. Price the actual scope and separate base-building deficiencies from tenant-specific work.
Healthcare Realty’s annual report separately discusses new and renewal TI commitments and leasing commissions. The distinction supports modeling those categories independently; its reported amounts should not be adopted as local assumptions. Healthcare Realty 2025 filing.
Hudson Pacific also presents new and renewal leasing costs separately in an original filing. Read definitions and periods before comparing any published metrics. Hudson Pacific first-quarter 2025 filing.
Get brokerage terms in writing. An assumed commission percentage is useful for screening but does not replace the actual payment arrangement. Check whether renewals, expansions, or early renewals have different obligations.
Rebuild expenses and recoveries in each case
The same base rent can have different owner economics under different expense structures. A renewal might reset a base year, change CAM caps, or leave major repairs with the landlord. A new tenant may negotiate different services, hours, or direct utility obligations.
Model gross operating expenses, reimbursements, vacant costs, and nonrecoverable items separately. A former tenant’s direct payment stops being protection when its obligation ends. During free rent, some charges may continue if the agreement provides it.
Do not assume every incremental operating cost can be recovered from other tenants. Use their actual leases. A proposed new use can affect parking, water, waste, insurance, and building-service costs as well as rent.
Discount the actual timing
Choose an explicitly stated discount rate for the decision and apply it consistently. A large payment today is more expensive in present-value terms than the same nominal payment years later. Early rent also has value.
For a simplified illustration, receiving $100,000 in one year has a present value of about $92,593 at an assumed 8% annual rate. Receiving it in three years has a value of about $79,383. The $13,210 difference comes only from timing. The chosen rate is not a claim about current market returns.
Calculate present value and maximum cumulative cash deficit together. A case with attractive NPV can still require more up-front capital than the owner can provide. Identify the source of that capital and its cost before recommending it.
Treat credit as a scenario, not a decorative score
Compare the legal obligor, guarantees, funded security, financial evidence, payment history, and location importance. A current tenant’s reliable history is relevant; it does not guarantee future performance. A replacement’s strong brand is relevant only to the actual tenant and support documents.
Run a downside in which the preferred tenant fails earlier than expected. Show security recovery only to the extent supportable and avoid counting the same protection twice. Include the cost of a second leasing event if material.
A slightly lower expected rent can be attractive when it reduces severe default exposure, but the decision should state that rationale. Do not hide a credit premium by changing several model inputs without explanation.
Residual value can change the comparison
At sale, a replacement might have more lease term remaining than a renewal. It may also have a different rent relative to market, an option, a termination right, or expensive future obligations. Model the buyer’s likely questions rather than capitalize year-five NOI mechanically.
If the existing tenant renews for only three years, a five-year hold may include another leasing event. If the replacement signs ten years, it may reduce later rollover while requiring more initial capital. Keep the timeline explicit.
Use more than one residual assumption where uncertainty is material. A favorable exit cap rate should not be the sole reason an expensive replacement appears superior. Separate operational value creation from speculative pricing improvement.
Understand published cost metrics before using them
A reported TI amount can mean committed cost, cash paid, cost per square foot, or cost per square foot per lease year. Exclusions for development, acquired vacancy, short terms, or major repositioning can change comparisons.
Kilroy’s annual report discloses definitions and exclusions around leasing-capital metrics and notes that cost varies with actual activity and market conditions. Use those disclosures as a reminder to check units and scope, not as a local cost schedule. Kilroy annual report.
For underwriting, retain the contractor’s actual scope and the lease’s payment obligations. Public data can frame questions, but it cannot certify that a specific Chicago suite can be delivered at a portfolio average.
Use probabilities carefully
A probability-weighted renewal model can summarize expected cost. If renewal costs $70,000 and replacement direct cash costs $276,000, a 60% assumed renewal probability produces $70,000 × 60% + $276,000 × 40% = $152,400 of expected direct cost.
The owner still needs a plan for the full replacement case. Expected cost is not an adequate liquidity reserve by itself. Multiple expirations can also be correlated through business conditions or a shared anchor.
Update probability as evidence develops, and keep signed agreements separate from negotiations. A tenant’s verbal intention to stay does not establish final economics or satisfy an option’s legal procedure.
Prepare the decision memo
Show both cases with common assumptions, differences, present value, funding requirement, residual exposure, credit, and unresolved evidence. Identify the rent or cost threshold where the recommendation changes. This turns the model into a negotiation tool.
For example, determine how much additional TI the owner could offer for a renewal before replacement becomes preferable, holding other assumptions constant. Then check whether that cash is available and whether the tenant’s request solves a real operating need.
After signing, reconcile the executed agreement with the approved model. Update rent, expense recovery, capital, security, dates, and lender approvals together. The strongest outcome is a documented choice whose economics remain understandable after the negotiation ends.