Key Takeaways
A rent roll is a snapshot of a schedule. Two assets with identical in-place net operating income can carry entirely different credit risk, because one has eight years of weighted average lease term ahead of it and the other has two.
Above-market in-place rents are a downside item. Coverage that depends on a rent the market will not pay again is coverage with an expiration date on it.
Re-tenanting costs land in the same period income drops. Tenant improvements, leasing commissions and free rent come due precisely when the space is dark, which is why a rollover reserve does more work than a debt service reserve on this asset type.
On value-add, the leasing plan is the credit. The trailing number describes the property the sponsor is buying. The plan describes the property that has to repay the loan.
The number everyone starts with
Commercial real estate credit runs on in-place income. An appraisal capitalizes it, a lender sizes to a coverage ratio against it, and both parties agree on a value that reflects what the building earns today. The process is sound and there is no better starting point.
It is a starting point. The loan will be outstanding for years, and over those years the income the loan was sized against gets rewritten one lease at a time. A building that produced a clean trailing twelve months can produce a coverage covenant breach eighteen months later without anything going wrong in the market, the submarket or the sponsor's management of the asset. The leases simply came up.
That is why PACT reads the rollover schedule before it reads the coverage ratio. Operator, property and plan get evaluated together on every transaction, and on a multi-tenant commercial asset the rollover schedule is where all three meet.
What the rollover schedule actually says
The first pass is arithmetic. How much rentable square footage expires in each year of the proposed term, and what share of total income does it represent. A building where twelve percent rolls annually in an orderly sequence is a different asset from a building where nothing rolls for four years and then forty percent rolls at once.
Concentration matters more than volume. A single tenant occupying a large share of the building, with an expiration inside the term and no remaining options, is the dominant fact in the credit regardless of how strong the trailing income looks. So is a cluster of expirations that all land in the same two quarters, because the sponsor cannot re-tenant them sequentially and cannot afford the downtime if they go dark together.
Weighted average lease term compresses most of this into one figure, and it belongs next to the coverage ratio in any summary of the transaction. It is the only number that answers how long the income being underwritten is contractually committed to exist.
Where the leases and the rent roll disagree
Rent rolls are prepared by property managers and they are frequently wrong in small ways that matter. Amendments that were never rolled into the summary. Expansion space at a different rate than the original premises. A renewal option that was exercised, or one that quietly expired.
The lease abstracts are where the credit gets confirmed, and a handful of provisions do most of the damage when they are missed:
Termination and kick-out rights. A stated expiration means little if the tenant can leave early on notice, or if a co-tenancy clause lets them go when an anchor does.
Recovery structure. A gross lease and a triple net lease produce the same headline rent and different net income the moment operating costs or property taxes move. Reassessment following a sale is a routine expense increase that gross leases absorb entirely.
Options and their rent. An extension option struck at a fixed rate below market is income the lender should not count on beyond the option date at anything above that rate.
Free rent and unfunded landlord obligations. Concessions still running, or improvement work the seller agreed to and never completed, are liabilities that arrive shortly after closing.
Estoppel certificates and subordination agreements are the mechanism for verifying this against the tenants themselves. They are also the point where discrepancies surface, which is a good argument for ordering them early rather than as a closing formality.
Mark to market, in both directions
Every lease in a building sits above or below what the space would rent for today, and each direction carries its own risk.
Below-market in-place rents are the thesis behind most value-add commercial acquisitions. They are also conditional. Capturing the spread requires the tenant to leave or renew at market, the sponsor to re-lease at the assumed rate, and the capital to fund the improvements the new tenant will require. Every one of those is a step where the plan can slip, and the underwriting should show what coverage looks like if the spread is captured late or partially.
Above-market rents are the harder case, because they flatter the file. Coverage looks strong, the appraisal supports the value, and the credit is sound right up to the expiration. At that point the choice is a renewal at a materially lower rate or a vacancy, and the loan was sized against neither. Legacy leases signed in a different market, or leases with long-dated escalators that outran rent growth, are worth identifying explicitly in any transaction where they represent meaningful income.
The cost of replacing a tenant
Vacancy is the visible cost. It is usually the smaller one.
Re-tenanting a commercial suite means a tenant improvement allowance, a leasing commission, some period of free rent, and downtime between the old tenant leaving and the new one paying. On second-generation space in most California markets, the improvement allowance alone can consume a meaningful share of the first years of the new lease. All of it is funded by the sponsor, and all of it comes due in the same window that the space is producing nothing.
The sequencing is what breaks sponsors. Income drops and capital requirements rise at the same moment, and a sponsor who budgeted for one of those has a problem when both arrive. This is why PACT weighs a sponsor's demonstrated ability to re-tenant this asset type in this submarket heavily. Leasing is a relationship business. A sponsor with an in-house leasing capability, or a long-standing brokerage relationship in the submarket, has a genuinely different probability of executing the plan than one who intends to hire someone after closing.
Where PACT structures around it
Rollover risk is manageable. It is rarely a reason to decline a transaction and it is frequently a reason to change how the transaction is built. The tools that come up most often:
Term set against the weighted average lease term. Where a major expiration lands inside the natural term, either the term shortens or the structure has to account for what happens at that date.
Rollover and improvement reserves. Funded at closing or from cash flow, sized to the improvement allowances and commissions the schedule implies rather than to a general contingency.
Cash management triggered by tenant events. Springing controls tied to occupancy thresholds, coverage tests or a major tenant's failure to renew by a stated date, rather than to a payment default that arrives well after the information did.
Holdbacks released against executed leases. Proceeds sized to the stabilized plan, funded as the plan is documented, with the release conditions written against signed leases and rent commencement rather than against letters of intent.
None of this is unusual in commercial real estate credit. The distinction is whether the structure was built from the rollover schedule or bolted on after a coverage ratio was already agreed.
What sponsors should bring
The diligence package that moves fastest is not the largest one. It is the one that anticipates the rollover question.
A rent roll reconciled to the leases, with amendments incorporated. Abstracts that state expirations, options, termination rights and recovery structure. A stacking plan and a rollover schedule by year. Historical improvement allowances and commissions actually paid at the property, which is better evidence of re-tenanting cost than any market survey. A leasing plan naming who will execute it. For any tenant representing meaningful income, whatever is known about their business at that location, including how long they have been there and whether they have expanded.
Sponsors who arrive with that get underwritten on their plan. Sponsors who arrive with a trailing twelve and an appraisal get underwritten on the lender's assumptions about the rollover, and those assumptions are conservative because they have to be.
The point
In-place income tells a lender what a building earns. The rollover schedule tells a lender how long it will keep earning it, what it will cost to keep earning it, and who has to perform for that to happen. Both belong in the file, and the second one belongs there before the loan is sized.