Skip to main contentSkip to navigationSkip to footer

CRE Analysis Exercises

10 min
4/6

Key Takeaways

  • Cap rates alone do not capture risk differences — NNN lease income at the same cap rate is more stable than gross lease income.
  • Normalizing different lease types to effective cost enables accurate comparison between properties.
  • Lease rollover concentration above 25-30% of income in any single year represents elevated risk.
  • Mark-to-market analysis reveals upside from below-market rents but requires successful tenant retention or replacement.

Practical CRE analysis requires fluency with core calculations and the ability to compare properties on an equal basis. This lesson presents four exercises that build calculation skills essential for CRE investment analysis.

1

Exercise 1: Cap Rate Calculation and Comparison

Calculate the cap rate for three properties and rank them by investor attractiveness, considering both yield and risk. Property A: 20,000 SF office, NOI $180,000, asking price $2,400,000. Property B: 8,000 SF NNN retail, NOI $72,000, asking price $960,000. Property C: 50-unit apartment complex, NOI $425,000, asking price $6,500,000.

Property A cap rate: $180,000 / $2,400,000 = 7.50%. Property B cap rate: $72,000 / $960,000 = 7.50%. Property C cap rate: $425,000 / $6,500,000 = 6.54%. Properties A and B have identical cap rates, but differ in risk profile — the NNN retail lease shifts expense risk to the tenant, making Property B's 7.50% yield arguably more attractive on a risk-adjusted basis. Property C's lower cap rate reflects the stability premium of multifamily assets.

2

Exercise 2: Office Building Rent Comparison

Two office buildings are available in the same submarket. Building 1 offers space at $28/SF full-service (gross lease). Building 2 offers space at $18/SF modified gross with a $6/SF expense stop, and current operating expenses are $9/SF. Which building offers the lower effective cost to the tenant?

Building 1 effective cost: $28/SF (all-inclusive). Building 2 effective cost: $18 base + ($9 - $6) expense overage = $18 + $3 = $21/SF. Building 2 is cheaper by $7/SF today. However, if operating expenses rise to $12/SF, Building 2 cost becomes $18 + ($12 - $6) = $24/SF, narrowing the gap to $4/SF. The expense stop structure means Building 2 tenants bear more expense inflation risk. Tenants should weigh current savings against future expense exposure when selecting lease structures.

3

Exercise 3: Lease Rollover Analysis

A 30,000 SF office property has the following lease schedule: Tenant A (10,000 SF, $22/SF, expires Year 1), Tenant B (12,000 SF, $24/SF, expires Year 3), Tenant C (8,000 SF, $20/SF, expires Year 5). Market rent is currently $26/SF. Analyze the rollover risk and mark-to-market opportunity.

Year 1 rollover risk: 33% of income (Tenant A). If Tenant A vacates, the property loses $220,000 in annual rent and incurs releasing costs (broker commissions at 4-6% of new lease value, TI allowance of $20-$40/SF). Mark-to-market opportunity: All three tenants are below market. Renewing at market rates would increase income from $700,000 to $780,000 — an 11.4% increase. However, this upside requires successful retention or replacement at each rollover date. A staggered rollover schedule (no more than 25-30% of income expiring in any single year) is considered healthy; 33% in Year 1 represents elevated concentration risk.

Rollover Risk Reality
When a major tenant vacates, the costs are not just lost rent. Budget 6-12 months of vacancy, $20-$40/SF in tenant improvements, and 4-6% in leasing commissions. For Tenant A's 10,000 SF, total releasing costs could reach $250,000-$450,000.

Key Takeaways

  • ✓Cap rates alone do not capture risk differences — NNN lease income at the same cap rate is more stable than gross lease income.
  • ✓Normalizing different lease types to effective cost enables accurate comparison between properties.
  • ✓Lease rollover concentration above 25-30% of income in any single year represents elevated risk.
  • ✓Mark-to-market analysis reveals upside from below-market rents but requires successful tenant retention or replacement.

Sources

Common Mistakes to Avoid

Treating mark-to-market rent increases as guaranteed income without considering releasing costs.

Consequence: Below-market leases appear to offer easy upside, but capturing that upside requires tenants to renew (or new tenants to sign), incurring TI costs, commissions, and potential vacancy that can offset 1-2 years of rent increases.

Correction: Net the releasing costs (TI, commissions, vacancy) against the projected rent increase to calculate the true mark-to-market benefit. Only count rent increases as value creation after deducting all associated costs.

Ignoring how lease type affects the comparability of cap rates across properties.

Consequence: Investors who compare a 7% NNN cap rate to a 7% gross cap rate believe they are equivalent, when in reality the NNN income carries significantly less expense volatility risk.

Correction: Always note the lease structure when comparing cap rates. NNN cap rates should be compared only to other NNN properties, and gross lease properties should be evaluated with expense risk adjustments.

Test Your Knowledge

1.Properties A and B both have a 7.5% cap rate. Property A has a NNN lease and Property B has a gross lease. Which is more attractive on a risk-adjusted basis?

2.What is a healthy maximum lease rollover concentration in any single year?

3.When a major tenant vacates, what costs should be budgeted beyond lost rent?

Previous LessonNext Lesson