How Vacancy Affects Office Building Value in Ontario: Recoveries, Rollover and Leasing Costs

Vacancy affects office building value more sharply than most owners expect, because a vacant floor removes both the rent it would have paid and the share of operating costs that a tenant would have reimbursed, while the building’s expenses keep running. Buyers then add the cost and time of re-leasing the space, including tenant improvements, commissions and free rent. This guide is for Ontario owners preparing to sell an office building and for investors underwriting one. It explains the types of vacancy, how vacancy flows through recoveries into net operating income (NOI) and value, why leasing costs are the office-specific problem, and how to present vacancy honestly to buyers. Numerical examples are hypothetical.

Types of Office Vacancy Buyers Distinguish

• Physical vacancy: space that is empty and available to lease.
• Economic vacancy: income lost to vacancy plus rent abatements, free rent, arrears and space that is leased but not yet paying rent.
• Sublease space: space a tenant is trying to sublet, which competes with the landlord’s own vacancy and signals a tenant that may not renew.
• Structural vacancy: space that stays empty because of layout, location, condition, parking or rent level.
• Pending vacancy: space that will become vacant on lease expiry or termination.

Buyers underwrite pending vacancy as well as current vacancy, since a building that is full today but has several leases expiring in the next two years may be riskier than one with modest vacancy and long leases in place.

How Vacancy Flows Through to NOI: A Hypothetical Illustration

The figures below are an arithmetic illustration only and are not market data. Suppose an office building has 100,000 rentable square feet, potential net rent of $24 per square foot when fully leased, and operating costs, property taxes and insurance of $1,000,000 a year that tenants reimburse in proportion to the space they occupy.

A ten-point increase in vacancy reduces NOI by $340,000, because both rent and recoveries fall while the cost of running the building does not. At the illustrative 7.0% cap rate, that is a difference of about $4.9 million in value. Buyers also deduct the cost of leasing the vacant space, which is a separate, one-time cost, explained below.

The Office-Specific Problem: Leasing Costs

Bringing vacant office space back into income normally involves:

• Tenant improvement (TI) allowances, the landlord’s contribution to the tenant’s fit-out.
• Leasing commissions paid to brokers.
• Free rent or other inducements.
• Downtime, the months in which the space is vacant while it is marketed and built out.

As a purely hypothetical example, a TI allowance of $40 per square foot on a 10,000 square foot floor is $400,000 before commissions, free rent or downtime. Buyers therefore value a partly vacant building as stabilized value minus the cost to lease up, and they price the risk that the lease-up takes longer or costs more than expected. See how to value an office building in Ontario.

What Buyers Ask About Vacancy

• How much space is vacant, how long has it been vacant and why?
• What has been done to lease it: marketing, pricing, inducements and inquiries received?
• What rents and inducements have recent leases in the building and in competing buildings achieved?
• Which leases expire in the next few years, and what are the tenants’ intentions?
• What condition is the vacant space in, and what would it cost to make it leasable?
• Is there sublease space in the building?

Answers supported by records, such as a leasing log, broker correspondence and letters of intent, are far more credible than general statements that the space is “in demand.”

Strategies for Owners

• Lease before selling, when it makes sense: a lease on terms buyers will value can increase value, but a weak or below-market lease signed only to fill space can reduce it. Discuss with your broker.
• Prepare spec or turnkey suites: modest investment in presentable space can shorten downtime.
• Renew strong tenants early: reducing pending vacancy can matter as much as filling current vacancy.
• Explain the plan: present a credible leasing strategy, with costs, timing and evidence.
• Consider the buyer pool: owner-users may value vacant space differently from investors. See how to sell an office building in Ontario.

Using Market Data Carefully

Buyers compare a building’s vacancy with vacancy in its submarket, drawing on brokerage research and their own market knowledge. Market figures describe broad categories and dates, not your building, so cite the source, date, geography and building class of any figure you use, and do not treat a submarket average as a substitute for evidence about your own space.

Common Mistakes

• Presenting current occupancy without disclosing pending expiries.
• Ignoring the effect of vacancy on recoveries.
• Assuming vacant space will lease quickly at asking rents.
• Failing to budget for tenant improvements, commissions and free rent.
• Signing a poor lease to reduce vacancy before a sale without considering how buyers will view it.
• Overlooking sublease space that competes with the landlord.

Frequently Asked Questions

How does vacancy affect office building value?

It reduces rent and recoveries while costs continue, and buyers deduct the cost and time of leasing the space, so the effect on value is usually larger than the lost rent alone.

Why do recoveries matter?

Tenants reimburse a share of operating costs, so when space is vacant the landlord bears that share.

Should I lease space before I sell?

Sometimes, if the lease is on terms buyers will value. A weak lease signed only to fill space can reduce value.

What is a tenant improvement allowance?

Money a landlord contributes toward a tenant’s fit-out of leased space.

What is pending vacancy?

Space that will become vacant on lease expiry or termination. Buyers price it alongside current vacancy.

Where can I find market vacancy data?

From commercial real estate brokerage research and other published market reports. Check the date, geography and building class.

Conclusion

Office vacancy hurts value through lost rent, lost recoveries and the cost of re-leasing, and pending expiries deserve as much attention as current empty space. Owners who document their leasing efforts, disclose rollover honestly and present a credible plan give buyers a basis for paying for the building’s income. If you are considering selling an office building in the GTA or Southern Ontario, a property-specific valuation and market strategy can help you understand your options before entering the market.

Sources and Further Reading

• Municipal Property Assessment Corporation: The Assessment Cycle
• Government of Ontario: Provincial Planning Statement, 2024
• Canada Revenue Agency: GST/HST Memorandum 19-4-1, Commercial Real Property Sales and Rentals

The figures in this article are hypothetical illustrations, not market data or an appraisal. This article is general information and is not legal, tax or accounting advice. Consult qualified professionals about your specific property.