Office renewal risk: expected cost versus capital that is actually committed

A probability-weighted leasing budget can be useful for planning, but it is not a funding commitment. Two buildings can have the same expected leasing cost and very different exposure to a large simultaneous cash requirement. For a multi-tenant office borrower, the important question is how renewal outcomes interact with one another and with the dates on which improvement allowances and commissions become payable.

Kilroy Realty’s 2025 Form 10-K reports renewal and replacement tenant improvement and leasing commission costs separately and explains that costs depend on lease, property and market circumstances. That issuer-specific disclosure supports separating the categories. Its historical averages are not a cost estimate for another property. Kilroy Realty, 2025 Form 10-K

Start with complete outcome costs

For each expiring tenant, calculate the cash required under renewal and replacement. Include improvement allowances, landlord work, commissions and carrying costs. Keep the operating income effect visible so it is not counted twice. A schedule that treats downtime as a leasing cost must reconcile it to the property operating forecast.

Then identify dependencies between tenants. Shared ownership, a common industry shock, a building relocation decision or the same access problem may make departures more correlated than a simple independent model assumes. Correlation is a scenario assumption requiring support, not a number that can be inferred from the building’s average renewal history.

Hypothetical example: identical averages, different tails

Assume two tenants expire at the same time. Each renewal requires $100,000 of total leasing cash. Each replacement requires $500,000, including all modeled downtime and capital. The owner assigns each tenant a 70% renewal probability solely for this example. These probabilities are illustrative, not a forecast or a market statistic.

If the renewal decisions are assumed independent, the joint outcomes are:

Expected cash cost is 49% × $200,000 + 42% × $600,000 + 9% × $1 million = $440,000. If the borrower reserves only that expected amount, the reserve is insufficient in either the one-replacement or two-replacement case. Under the stated independent model, those outcomes have a combined 51% probability.

Now assume an extreme shared-dependency scenario: both tenants renew together 70% of the time and both leave together 30% of the time. Each tenant still has the same marginal 70% renewal probability. Expected cost remains 70% × $200,000 + 30% × $1 million = $440,000. Yet the $1 million outcome rises from 9% to 30%.

The second case actually has fewer occasions on which the $440,000 reserve is exceeded, but a larger probability of the most severe shortfall. This distinction matters. “Probability of any shortfall” and “size of a severe shortfall” answer different questions; neither is interchangeable with the expected budget.

Real properties rarely fit either extreme exactly. Use the examples to identify an assumption worth investigating, not to assign a precise likelihood without evidence.

Convert modeled need into available capital

Suppose the loan has a $300,000 leasing reserve, the sponsor has authorized $200,000 of additional cash, and a potential partner has discussed another $500,000 without signing a commitment. Only $500,000 is currently identified as committed under these assumptions. The partner conversation belongs in a separate prospective-source column.

The $600,000 case has a $100,000 funding gap and the $1 million case has a $500,000 gap. The existence of a reserve does not ensure timely availability: eligible-cost limits, reimbursement conditions and draw processing may require the sponsor to bridge invoices first. A reserve funded with debt also remains debt and should be reconciled to outstanding principal.

Prepare a monthly calendar for each joint outcome. Include lease decision deadlines, allowance due dates, commissions, construction draws, rent commencement and debt service. Two scenarios with the same total cost can have different peak cash needs if one requires overlapping construction payments.

Use the result in the loan decision

The financing discussion should specify which cases the borrower intends to fund, which source covers each case and which decisions remain conditional. Possible responses include a larger funded reserve, documented sponsor capital, a smaller initial advance or staged work. Their availability depends on actual loan terms and sponsor resources.

Update the model when a renewal is executed. Remove obsolete probabilities, replace estimates with contractual commitments, and retain a change log showing the impact on both total cost and peak cash. A signed renewal reduces one uncertainty but can create a fixed allowance obligation. The proper conclusion is therefore not simply that risk has fallen; it is that the mix of uncertain outcomes and binding cash obligations has changed.