Commercial real estate (CRE) refers to income-producing properties acquired for cash flow, appreciation, or both. While industrial, retail, office, and multifamily assets differ operationally, the economic framework is consistent: rental income funds expenses, and NOI drives value.
A proforma translates that framework into projected financial performance. Within it, vacancy and loss to lease are separate assumptions that impact income in different ways and should be analyzed independently.
What is Loss to Lease?
Loss to lease is the difference between a property’s contractual rents and the rents that same space could command at current market rates. It is not a realized loss in the traditional sense. Instead, it represents unrealized income.
This condition commonly arises because commercial leases are long term. Lease terms of three, five, or even ten years provide income stability, but they also lock in rental rates. If market rents rise faster than contractual escalations, a gap develops.
For example, if a tenant leases 1,000 square feet at $10 per square foot while comparable space leases for $12 per square foot, the loss to lease is $2 per square foot, or $2,000 annually for that tenant.
On a proforma, market rent is typically shown as Gross Potential Rent (GPR), with loss to lease deducted to arrive at effective rental income. A meaningful loss to lease can indicate outdated lease terms, deferred maintenance, or rapid rent growth in the surrounding market.
Loss to Lease as a Value-Add Opportunity
Loss to lease can occur for two primary reasons.
First, poor or deferred property maintenance can cause an asset to fall below market standards. Tenants are unwilling to pay market rents for space that lacks proper upkeep, modern finishes, or reliable building systems.
Second, loss to lease can occur in high-growth markets where rising rents outpace the fixed escalations built into long-term leases. In this case, the issue is not property quality, but timing.
Each scenario requires a different response. If the issue is physical condition, targeted capital improvements and improved management can justify higher rents. If the issue is lease structure, rents can be reset to market as leases roll over. Both approaches require time, capital, and execution discipline.
For value-add investors, closing the loss to lease gap is one of the more direct ways to increase NOI without relying on aggressive assumptions. As rents move closer to market, income improves, cap-rate value increases, and the property’s risk profile often strengthens alongside returns.
What is Vacancy?
Commercial properties are typically divided into multiple units or leasable spaces. A multifamily property may contain dozens or hundreds of apartments, while a retail asset may consist of several storefronts totaling tens of thousands of square feet.
Vacancy represents the portion of that space that is physically unoccupied. Because tenants move in and out over time, vacancy is best viewed on an annualized basis rather than at a single point in time.
For example, if a 100-unit apartment building averages 10 vacant units for half the year, its annual vacancy rate is 5%. This vacant space produces no rental income and directly reduces effective gross income.
Vacancy reflects a utilization issue—space that is not leased at all. Loss to lease, by contrast, reflects a pricing issue.
Why Vacancy and Loss to Lease Matter
Commercial properties are valued based on the NOI they generate. NOI equals total income minus operating expenses, and higher NOI generally translates into higher value.
Vacancy reduces NOI by eliminating rental income entirely. Loss to lease reduces NOI more subtly by limiting income to below-market levels. In both cases, the property’s cash flow—and therefore its valuation—may be artificially depressed.
Because commercial values are derived by capitalizing NOI at a market cap rate, even modest improvements in income can produce outsized changes in value. This relationship is what makes vacancy and loss to lease so important to investors evaluating both risk and upside.
Putting it Together
Vacancy and loss to lease are distinct metrics that affect commercial real estate performance in different ways. Vacancy reflects unused space. Loss to lease reflects underutilized pricing power.
When analyzed correctly, both provide insight into a property’s operational health and its potential for improvement. For experienced investors, assets with elevated vacancy or loss to lease are not inherently flawed—they are often mispriced. When the underlying issues are solvable, these conditions can form the foundation of a disciplined, risk-aware value-add strategy.
