Lease Rollover Risk and Term Structure Impact on Income Stability

Main KPI: Lease Expiry Concentration Ratio
Primary Keywords: lease rollover risk, term structure, income stability, renewal probability, vacancy downtime, rent reset volatility, maturity ladder modeling

1. Introduction: Lease Term Structure as an Embedded Risk Curve

Real estate income is fundamentally contractual. Unlike many operating businesses, revenue is governed by leases that specify:

• rent level

• escalation clauses

• expiration dates

• renewal options

• tenant obligations

Thus, the stability of NOI is not only a function of occupancy today, but the lease term structure, which determines when income contracts reset.

Lease rollover risk arises because lease expirations create discontinuities in:

• cash flow certainty

• vacancy probability

• rent repricing exposure

• tenant credit risk

Institutional asset managers therefore treat lease maturity profiles analogously to fixed-income duration curves.

2. Defining Lease Rollover Risk

Lease rollover risk is the probability-weighted impact of leases expiring and resetting under uncertain market conditions.

Formally:

RolloverRisk=∑i=1NRenti⋅Pi(non-renew)⋅LossSeverityiRolloverRisk = \sum_{i=1}^{N} Rent_i \cdot P_i(\text{non-renew}) \cdot LossSeverity_iRolloverRisk=i=1∑N​Renti​⋅Pi​(non-renew)⋅LossSeverityi​

Where:

• RentiRent_iRenti​ = income from tenant iii

• PiP_iPi​ = probability tenant does not renew

• LossSeverityiLossSeverity_iLossSeverityi​ = downtime + rent reset loss

3. Main KPI: Lease Expiry Concentration Ratio

3.1 KPI Definition

LECR=Rent expiring within horizonTotal RentLECR = \frac{\text{Rent expiring within horizon}}{\text{Total Rent}}LECR=Total RentRent expiring within horizon​

Typical horizons:

• 12 months

• 24 months

• 36 months

Example:

LECR24m=15M50M=30%LECR_{24m} = \frac{15M}{50M} = 30\%LECR24m​=50M15M​=30%

3.2 Interpretation

High LECR implies structural instability even if occupancy is currently high.

(See Topic 1 for volatility propagation.)

4. Lease Maturity Ladder Modeling

4.1 Lease Expiry Schedule

The maturity ladder is a distribution:

M(t)=∑Renti⋅1{Expiryi=t}M(t) = \sum Rent_i \cdot 1_{\{Expiry_i=t\}}M(t)=∑Renti​⋅1{Expiryi​=t}​

Graphically, it resembles a bond maturity curve.

4.2 Weighted Average Lease Term (WALT)

A standard term structure metric:

WALT=∑Renti⋅Termi∑RentiWALT = \frac{\sum Rent_i \cdot Term_i}{\sum Rent_i}WALT=∑Renti​∑Renti​⋅Termi​​

Where:

• TermiTerm_iTermi​ = years remaining

WALT is a duration proxy, but LECR captures concentration.

4.3 Duration Risk Analogy

Just as short-duration bond portfolios face reinvestment risk, short-WALT assets face:

• rent repricing volatility

• renewal uncertainty

• vacancy downtime risk

5. Renewal Probability as a Stochastic Process

5.1 Renewal Modeling

Renewal is probabilistic:

Pi(renew)=f(RentGapi,Crediti,Fiti,Markett)P_i(\text{renew}) = f(RentGap_i, Credit_i, Fit_i, Market_t)Pi​(renew)=f(RentGapi​,Crediti​,Fiti​,Markett​)

Key drivers:

• rent premium vs market

• tenant business stability

• relocation costs

• asset quality

5.2 Logistic Renewal Model

Pi(renew)=11+exp⁡(−(βXi))P_i(\text{renew}) = \frac{1}{1+\exp(-(\beta X_i))}Pi​(renew)=1+exp(−(βXi​))1​

Where XiX_iXi​ includes:

• rent delta

• tenant size

• lease incentives

• vacancy rate

5.3 Renewal Hazard Function

Using survival analysis:

h(t)=P(exit at t∣survive to t)h(t) = P(\text{exit at }t|\text{survive to }t)h(t)=P(exit at t∣survive to t)

This provides forward rollover risk curves.

(See Topic 1 Section 4 for churn hazard modeling.)

6. Downtime and Vacancy Loss Severity

Non-renewal triggers downtime:

Loss=Renti⋅VacancyDurationiLoss = Rent_i \cdot VacancyDuration_iLoss=Renti​⋅VacancyDurationi​

Vacancy duration is stochastic:

Di∼N(μd,σd2)D_i \sim \mathcal{N}(\mu_d,\sigma_d^2)Di​∼N(μd​,σd2​)

Expected downtime cost:

E[Loss]=Renti⋅E[Di]E[Loss] = Rent_i \cdot E[D_i]E[Loss]=Renti​⋅E[Di​]

High volatility implies tail risk of extended vacancy.

Example

Tenant rent: $2M/year
Expected downtime: 6 months

Loss=2M⋅0.5=1MLoss = 2M \cdot 0.5 = 1MLoss=2M⋅0.5=1M

If downtime variance increases, worst-case losses rise disproportionately.

7. Rent Reset Volatility at Expiry

Lease expiry introduces rent repricing:

Rentnew=Rentold(1+ΔMarketRent)Rent_{new} = Rent_{old}(1+\Delta MarketRent)Rentnew​=Rentold​(1+ΔMarketRent)

Market rent changes are stochastic:

ΔMarketRent∼N(μ,σ2)\Delta MarketRent \sim \mathcal{N}(\mu,\sigma^2)ΔMarketRent∼N(μ,σ2)

Thus, rollover creates both:

• vacancy risk

• rent reset risk

7.1 Downside Rent Reset Scenario

If market rents fall 15%:

Rentnew=0.85RentoldRent_{new} = 0.85 Rent_{old}Rentnew​=0.85Rentold​

NOI impact persists over full new lease term.

7.2 Upside Rent Reset

Conversely, expiring leases create mark-to-market upside.

Thus rollover risk is asymmetric:

• downside: vacancy + rent drop

• upside: rent growth capture

8. Multi-Tenant Concentration Risk

Rollover risk increases with tenant concentration.

Define tenant concentration:

TC=max⁡iRentiTotalRentTC = \max_i \frac{Rent_i}{TotalRent}TC=imax​TotalRentRenti​​

High TC implies a single expiry event can destabilize NOI.

Example

If top tenant contributes 25% of rent:

• non-renewal triggers immediate NOI drawdown

• DSCR covenant breach probability rises

(See Topic 3 DSCR modeling.)

9. Lease Rollover Stress Testing

9.1 Scenario-Based Analysis

Stress test:

• 30% of expiring tenants do not renew

• downtime = 9 months

• rent reset = -10%

Compute NOI shock:

NOIstress=NOIbase−Lossvacancy−LossrentresetNOI_{stress} = NOI_{base} - Loss_{vacancy} - Loss_{rentreset}NOIstress​=NOIbase​−Lossvacancy​−Lossrentreset​

9.2 Monte Carlo Rollover Simulation

Simulate:

• renewal Bernoulli outcomes

• downtime distributions

• rent reset shocks

For each path:

NOIt(j)NOI_t^{(j)}NOIt(j)​

Then compute:

• NOI-at-risk

• DSCR breach probability

• occupancy volatility increase

(Links Topic 1 + Topic 3.)

10. Term Structure Optimization Strategies

10.1 Expiry Staggering

Reduce LECR by smoothing maturities:

• extend leases selectively

• stagger renewals

• diversify tenant mix

Goal:

LECR12m<20%LECR_{12m} < 20\%LECR12m​<20%

10.2 Renewal Incentive Engineering

Offer tenant improvements or rent discounts to lock renewal.

Optimization tradeoff:

CostTI<ExpectedVacancyLossCost_{TI} < ExpectedVacancyLossCostTI​<ExpectedVacancyLoss

10.3 Lease Duration Extension

Increase WALT:

WALTtarget>5 yearsWALT_{target} > 5 \text{ years}WALTtarget​>5 years

Longer leases reduce volatility but may cap upside.

11. Lease Term Structure Impact on Valuation

Valuation depends on income certainty.

Cap rates compress with stable lease ladders:

Value=NOICapRateValue = \frac{NOI}{CapRate}Value=CapRateNOI​

High rollover risk increases cap rate:

CapRate=CapRatebase+RiskPremiumrolloverCapRate = CapRate_{base} + RiskPremium_{rollover}CapRate=CapRatebase​+RiskPremiumrollover​

Thus, term structure directly affects valuation multiple.

12. Summary of Key Technical Takeaways

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