Loss to Lease
Loss to lease is the gap between the rent a property collects under its existing leases and the rent the same space would command at current market terms. It measures income that is available on paper but not yet earned, so it is a mark-to-market signal and no part of cash flow. Lease expiry dates, renewal rights and the cost and downtime of reletting decide when, and whether, the gap turns into collected rent.
How the gap is computed and which denominator it uses
For one suite, the annual gap is market rent per square foot minus contract rent per square foot, multiplied by the leased area. Summed across the rent roll, the result is total loss to lease in dollars.
The same dollars can be quoted against two bases. Divided by market rent, the figure shows how much of achievable rent is unrealized. Divided by contract rent, it shows how far rents would have to rise. Whenever contract rent sits below market, the second percentage is the larger of the two.
Two quoted figures for one building can therefore differ by a wide margin, and the basis belongs next to the number.
Why a long lease holds the gap in place
Until a lease ends or a reset provision in the lease applies, contract rent governs collections. A below-market lease with years remaining can show a large gap and produce no increase in income.
Valuation treatments for industrial property penalize longer leases at below-market rents for the unrealized revenue potential. The remaining term matters as much as the size of the gap.
A large gap on space expiring soon can convert on a short timeline. The same gap on a long lease may stay unrealized through much of an ownership period.
Between expiry and new rent sits the cost of capture. Downtime, free rent, tenant improvements and commissions all come out of the gap before any of it reaches net income.
The gap can also move before expiry. If market rent falls, the gap narrows with no action by either party.
How a rising rent cycle widens the gap and a supply wave narrows it
Industrial rents climbed to historic highs while e-commerce demand accelerated. Leases signed earlier in that climb stayed at their original rents, so the distance between contract and market rent grew.
Institutional research put the industrial rent loss-to-lease differential at roughly 40% in one quarter, the widest on record.
That reading is a market-wide peak. It gives no rent estimate for any single building, whose gap depends on its own leases and its own comparable space.
The opposite force works through the market side. In one annual outlook, new industrial supply reached nearly 2% of existing stock and industrial REIT vacancy approached 6%. Heavier supply and higher vacancy can press market rents, and a lower market rent shrinks the gap with no change to any lease.
Net rent, free rent and escalations: putting both sides on one basis
A gap means something only when contract rent and market rent describe the same lease structure. Comparing a net contract rent with a gross market quote overstates the gap by the size of the expense load, because the operating costs sit inside one figure and outside the other.
Concessions belong in the comparison too. A market rent quoted at face value with several months free is worth less than its face figure, and effective rent spreads the concessions across the term.
Escalations change the picture over time. A contract with fixed annual steps closes part of the gap automatically, while a flat contract leaves it open. The rent roll shows the gap at one date, and the gap at expiry will differ from it.
Worked example: a 100,000 square foot industrial building with rents below market
The hypothetical building is 100,000 square feet, fully leased to one tenant at $8 per square foot per year on a triple net basis, so recoveries cover operating costs. Market rent for comparable space is $10 per square foot and stays flat for the whole period.
Contract rent is 100,000 multiplied by $8, or $800,000. Market rent is 100,000 multiplied by $10, or $1,000,000. Loss to lease is $1,000,000 minus $800,000, or $200,000 per year. Against market rent, that is 20% ($200,000 divided by $1,000,000).
Both cases use the same building, the same five-year horizon and the same market rent. In the first case the lease ends after one year, the space sits vacant for 6 months, and it is then relet at market. Reletting costs $1.50 per square foot in tenant improvements and commissions combined, and the owner carries $1 per square foot per year of nonrecoverable cost during the vacancy. In the second case the lease runs the full five years at $8.
First case, step by step. Rent in the first year is $800,000. In the second year the space earns market rent for 6 of 12 months: $1,000,000 multiplied by 6, divided by 12, or $500,000. The first two years together bring $800,000 plus $500,000, or $1,300,000. Years three to five bring 3 multiplied by $1,000,000, or $3,000,000. Gross rent over five years is $1,300,000 plus $3,000,000, or $4,300,000.
Costs in the first case. Tenant improvements and commissions are 100,000 multiplied by $1.50, or $150,000. Carry during the vacancy is 100,000 multiplied by $1, multiplied by 6, divided by 12, or $50,000. Net rent is $4,300,000 minus $150,000 minus $50,000, or $4,100,000.
Second case. Five years at $800,000 is $4,000,000.
The first case ends $100,000 ahead ($4,100,000 minus $4,000,000). The paper gap over five years is 5 multiplied by $200,000, or $1,000,000, so the first case captured 10% of it ($100,000 divided by $1,000,000).
Vacancy and reletting costs consumed most of the paper gap inside this horizon. The second case reaches its own reset only when its lease ends, which falls beyond the five years shown. The comparison leaves out discounting, rent growth and any chance of renewal.
How the gap enters value without becoming income
Capitalizing in-place net operating income values the contract stream. A buyer or appraiser who credits the gap pays for income not yet collected, and that credit has to be reduced by the waiting period and by the vacancy and reletting costs the example shows.
A cap rate is one year of net operating income divided by price. It says nothing about a return over a hold, so a mark-to-market income figure capitalized at the same rate as in-place income treats the gap as if it were already earned.
The building whose below-market leases run longer takes the larger penalty, since the revenue potential stays unrealized for more of the hold.
Pitfalls in reading loss to lease
Adding the gap to current net operating income overstates present operations. In the example, collected rent stays at $800,000 until the lease ends, whatever the market rent is.
Applying a market-wide differential to a single building mixes an average with a specific rent roll. The roughly 40% industrial differential from one quarter spans many leases and many buildings. A particular building has its own contract rents against its own comparable space, and the example building shows 20%.
Reading the gap as profit ignores the cost of capture. The example building carries a 20% gap against market rent, yet vacancy costs and improvements leave only 10% of the five-year paper gap as extra net rent.
Quoting the gap on the wrong base distorts comparisons. The same $200,000 is 20% of market rent and 25% of contract rent ($200,000 divided by $800,000). A pro forma that states one percentage and a rent roll summary that states the other appear to disagree when they agree.
Holding market rent flat across a long hold treats a moving difference as a fixed asset. The gap is market rent minus contract rent, so it narrows when market rent falls and widens when market rent rises faster than leases reset.
Questions that test whether a rent gap can be captured
Are contract rent and market rent stated on the same lease basis, net or gross, face or effective? The gap is only as reliable as that match.
Which leases hold the largest dollar share of the gap, and when does each one end? Expiry timing separates near-term conversion from distant potential.
Do any leases carry fixed steps or reset provisions that close part of the gap before expiry? Those leases narrow the gap on a schedule the rent roll can show.
What market rent applies to this building’s size and location? A sector differential is an average across many buildings.
How many months of downtime, and what concessions and improvement costs, sit between expiry and the new rent? In the example those costs absorbed most of the paper gap over five years.
What happens to the gap if market rent holds flat, falls or rises over the hold? The gap is a difference between two numbers and moves with either one.
Does the valuation or pro forma count the gap as income already earned? Capitalizing mark-to-market income at the in-place yield would count it before collection.