Your building just went 40% vacant. Maybe you bought it that way. Maybe you had a tenant or two move out. Either way, that empty space is now the most expensive thing you own, and what you do next decides whether you walk away from this deal up sixty grand or down eighty-seven.
That’s not a typo. On the exact same building, how you handle commercial real estate vacancy is worth a $147,000 swing between the best fix and the worst one. Same building, same tenant, same effective deal. The only thing that changes is how you sign the lease. That’s it.
So walk through this scenario with me. One building, 20,000 square feet, five suites of 4,000 feet each. I bought it for $3.75 million at an 8% cap rate. Two suites are empty. And by the end of this, you won’t be nearly as scared of a vacancy as most investors are, because you’ll know the math cold.
In This Article
What 40% Vacancy Actually Costs You
What Vacancy Does to Your Loan
Why You Never Sell Into Vacancy
One Building, Four Ways to Fill It
The Number That Should Drive the Decision
40% Vacancy, By the Numbers
$300K → $140K
NOI when 40% goes empty
0.64x
Debt service coverage (default territory)
$3.75M → $1.75M
Value at an 8% cap rate
What 40% Vacancy Actually Costs You
Start with the income, because the first number surprises almost everybody. When your building goes 40% empty, you don’t lose 40% of your income. You lose 53%. In a triple net lease, the empty suite still owes property taxes, insurance, and common area maintenance. When the tenant moves out, they stop paying those. You start paying them.
Run the numbers on our building. Fully leased, the net operating income is $300,000. The rent lost on 8,000 vacant square feet is $120,000. Then the operating expenses those tenants used to cover, roughly 30% to 35%, is another $40,000 that now lands on you. So your NOI drops from $300,000 to $140,000. The lost rent isn’t the whole story. The expenses are the rest, and they are the part people forget.
What Vacancy Does to Your Loan
Now look at the loan, because this is where a vacancy turns from painful to dangerous. In this deal we are at 65% loan to value, a 6.5% interest rate, and a 20-year amortization. That is an 8.95% loan constant, so you’re not just paying 6.5% interest, you’re paying back principal on top of it.
At 40% vacancy, your debt service coverage ratio comes in at 0.64. Lenders want to see 1.25. That means the building doesn’t make enough to cover its own mortgage, so technically you’re in default. Your lender probably won’t call the loan immediately, because vacancy is normal, but they will put you on a clock, maybe 12 months, maybe 24, depending on your relationship. In the meantime you are writing a check for about $6,500 a month, roughly $78,000 a year, to keep the property alive.
Break-even occupancy here is 80%, four of five suites just to stop bleeding. And you have to hit 93% occupancy before a lender will touch you again. Sitting 40% vacant, the building isn’t an asset. It’s borrowing money from you.
Why You Never Sell Into Vacancy
The value tells the same story. At an 8% cap rate, fully leased, the building is worth $3.75 million. On the in-place income at 40% vacancy, it is worth $1.75 million. That is $2 million of value gone on paper. Your loan balance is around $2.4 million, which means you’re underwater, and it is exactly why I tell people to never sell a building with more than 10% vacancy if they can help it. (Putting a price on a fully empty building is its own exercise, which I break down in how to value a completely vacant building.)
The mechanism underneath all of this is forced appreciation, and it cuts both ways. At an 8% cap rate, every $1 of NOI is worth about $12.50 of value. That is the magic of commercial real estate, where you put in a dollar and the market hands you back twelve and a half. But flip it around, and every $1 you knock off your NOI erases $12.50 of value. Hold that thought, because it decides the whole game.
One Building, Four Ways to Fill It
The deal we’re filling is this: 20,000 feet, five suites, bought at $3.75 million on an 8% cap. Rent is $15 a foot triple net, expenses are $5 a foot and fully reimbursed, and 8,000 feet across two suites are empty. I ran all four of these through my Deal Analyzer, which is how I underwrite every deal now. Watch what changes.
The base case: wait 12 months, lease at full rent
You hold out, keep the ask at $15 a foot, and fill the space in a year. Year one stings at negative $78,000, but the five-year profit lands around $589,000 and you sell at the full $3.75 million. This is the number every other option gets measured against.
Pass one: cut the rent (the worst move)
This is what most people do, and it’s the trap. Drop the rent to $13.50 a foot and lease six months faster, just to get a body in the space. And yes, you’ll lose less in year one. But that $13.50 stays on the rent roll, your gross rent maxes out around $288,000, and your sale price slips to $3.6 million. Total five-year profit comes in about $87,000 lower than if you had simply waited. You threw $87,000 out the window to fill the space a few months sooner.
Pass two: spend on the space
Put $10 a foot into improvements, about $80,000, and lease at full rent three months faster because the suite is move-in ready. Same NOI, same $3.75 million exit, but year one only loses about $38,000 instead of $78,000. Over five years you come out roughly $40,000 ahead of waiting. That $80,000 of build-out comes back as nine months of rent you never lost. If you are going to spend, this is how, and a tenant improvement allowance is the mechanism.
Pass three: give free rent (the best move)
Keep the ask at $15 a foot, but give the tenant six months of free rent. To the tenant, that is the same effective deal as the $13.50 cut. To you, it’s a completely different outcome. The free months burn off before you ever sell, so your rent roll still shows $15 and your sale price stays at the full $3.75 million. Nobody discounts you for it. You come out about $60,000 ahead of waiting, and a full $147,000 ahead of cutting the rent, for the exact same deal on the tenant’s side.
Four Ways to Fill It, vs. Waiting
−$87K
Cut the rent to $13.50
+$40K
Spend $10/ft on improvements
+$60K
Give six months of free rent
The Number That Should Drive the Decision
Every fix should be measured against one number: what an empty month actually costs you. At $20 a foot all in, that is $15 base rent plus $5 in triple net, an empty suite costs about $1.67 per square foot every single month it sits there. Price every decision against it.
That single number explains all three fixes. A $10-a-foot build-out pays for itself if it saves six months of vacancy, because $1.67 times six is ten dollars. And giving time instead of rate is almost always the right call, because a $1 cut in rent costs you $12.50 a foot in value, while free rent costs you nothing at the sale. Give time, not rate. Write that one down.
Why Free Rent Beats a Rent Cut
Free rent wins for one reason: it never touches your rent roll. The tenant gets the same effective deal as a rent cut, but when you go to sell, the buyer is buying the $15 a foot that is on paper, not the months you gave away. Rate cuts are permanent. Free rent isn’t. And the exit value beats today’s cash flow every single time, because you can survive a cash crunch, but you cannot un-cut a rent.
One hard rule, though: free rent is for qualifying tenants only. Don’t hand it out without doing the work. I still want a personal guarantee, one to three months of security deposit, the first month’s rent, and a real look at their financials. If I’ve got any doubt, I’ll ask for a letter of good standing from their last landlord. Give free rent to a tenant who never performs and you have combined the worst of both worlds, no cash and no value. The concession only works when the tenant does.
Key Takeaways
A 40% vacancy costs you 53% of your income. With triple net leases, the empty suite’s taxes, insurance, and CAM flip from the tenant to you. NOI drops from $300K to $140K, not to $180K.
Vacancy can put you in technical default. At 0.64x debt coverage you are not covering the mortgage. Break-even here is 80% occupancy, and you need 93% before a lender will refinance you.
Never sell into vacancy. On in-place income the building is worth $1.75M against a $2.4M loan. That is underwater. Keep cash on hand so you are never forced to sell at the bottom.
Every $1 of NOI is worth $12.50 of value. At an 8% cap rate, forced appreciation runs both directions. A $1 rent cut does not cost you a dollar, it costs you $12.50 a foot in value.
Give time, not rate. Cutting rent is the worst fix, $87K behind waiting. Free rent is the best, $60K ahead, because it burns off before you sell and never touches the rent roll.
Free rent is for qualifying tenants only. Vet them the same way you would any lease: personal guarantee, security deposit, first month’s rent, and their financials. The concession only pays off when the tenant does.
This article is adapted from a conversation on the Tyler Cauble YouTube channel, from a live Office Hours episode of the Commercial Real Estate Investor podcast. Watch the full walkthrough to see every scenario run through the Deal Analyzer.
Want me running your vacancy scenarios with you?
Get my step-by-step investment blueprint, the underwriting software, and personalized feedback on every deal inside the CRE Accelerator.
Learn About the CRE Accelerator