Over the years, we’ve worked with many investors who started out in multifamily investing and eventually moved into commercial property investing. Several of them have been surprised by the differences in leasing structure and timing.
Most commercial and industrial properties have lease terms that range from 2-10 years, with some highly specialized properties leasing beyond ten years. Commercial tenants will often stay for many years and it’s not unusual for those 10 year leases to be renewed multiple times. However, vacancy periods caused by turnover between tenants can often be much longer than in residential properties. The longer vacancy is balanced out by the longer lease.
Overall, the vacancy rates can be similar to multifamily, depending on the commercial class. For instance, office properties will have a higher vacancy of around 8%, while industrial is 7% and retail sits at about 4.7% in the Harrisburg region. Currently, multifamily vacancy rates are about 6% for the same area.
If you own or are considering purchasing a commercial property, how can you anticipate the longer vacancy period between tenants? The “WALT” is a measurement that can help.
What is a WALT?
WALT stands for weighted average lease term, a fundamental metric used in the real estate investment world to assess the stability and income potential of commercial properties. Essentially, it measures the average amount of time left for all of the property’s current leases. Rather than a simple average, though, the figure is weighted by taking the size of each tenant into account.
WALT is particularly relevant in commercial real estate assets like office buildings, shopping centers, and industrial facilities, where multiple tenants may hold leases of varying lengths. A longer WALT indicates that the property has a stable, long-term income with low immediate lease renewal risk. Conversely, a shorter WALT suggests that several leases are expiring soon, which may mean future vacancies or renegotiation at different rental rates.
How to Calculate Weighted Average Lease Term
The WALT calculation combines the remaining lease term of each tenant, the area leased, and the income each lease generates. A simplified version of the formula is below:
This formula accounts for each lease’s income contribution, providing a weighted average of the lease durations.
Example
Midtown Executive Spaces is a mixed-use development featuring a blend of office, retail, and residential spaces.
Their tenants are:
- Tech Innovate Inc., a technology company renting 10,000 square feet at $45 per square foot annually, with 5 years remaining on their lease
- Creative Designs Co., a marketing agency occupying 5,000 square feet and paying $45 per square foot annually, with 3 years left
- HealthFirst Clinic, an urgent care center using 3,000 square feet and paying $60 per square foot annually, who has 10 years remaining on their lease
- Farm to Table Bistro, a restaurant taking up 2,000 square feet at $70 per square foot annually, with 2 years left
- City Books, a bookstore with 1,000 square feet at $40 per square foot annually, with 1 year remaining on their lease
To calculate the weighted average lease term for this property:
- Calculate the current annual rent for each tenant:
- Annual rent is found by multiplying the square footage that the tenant is occupying by their rent per square foot annually.
- Tech Innovate Inc: 10,000 square feet x $50 rent per square foot = $500,000.
- Creative Designs Co: 5,000 square feet x $45 per square foot = $225,000.
- HealthFirst Clinic: 3,000 square feet x $60 per square foot = $180,000.
- Farm to Table Bistro: 2,000 square feet x $70 per square foot = $140,000.
- City Books: 1,000 square feet x $40 per square foot = $40,000.
- Multiply the current annual rent for each tenant by the remaining lease term for each tenant.
- Tech Innovate Inc: $500,00 x 5 years = $2,500,000
- Creative Designs Co: $225,000 x 3 years = $675,000
- HealthFirst Clinic: $180,000 x 10 years = $1,800,000
- Farm to Table Bistro: $140,000 x 2 years = $280,000
- City Books: $40,000 x 1 year = $40,000
- Total the figures from the previous step
- $2,500,000 + $675,000 + $1,800,000 + $280,000 + $40,000 = $5,295,000.
- Divide the total from the previous step by the sum of the current annual rents for all tenants
- $500,000 + $225,000 + $180,000 + $140,000 + $40,000 = $1,085,000
- $5,295,000 / $1,085,000 = 4.88
The calculated WALT of approximately 4.88 years provides potential investors and lenders with insight into the average timeframe that the current tenants are expected to continue generating rental income, which is crucial for financial projections and risk assessment.
What is a good WALT?
Typically, you should look for a WALT of at least 3 years, thought the number will vary depending on the asset class.
For instance, flex industrial properties usually have a shorter WALT because many flex tenants rent a smaller amount of space and term lengths are usually around 3 years.
When you compare a flex industrial property to a large, multi-tenant office building, it’s easy to understand why the office building would typically have a longer WALT. Large office tenants tend to sign longer leases, and many large office buildings have at least one tenant using a very large amount of space.
To be specific, look for a WALT of 3 years or more for flex assets, and look for a WALT of 5 years or more for office assets.
Why WALT Matters for Investors
The weighted average lease term can help you to determine how much work you’ll need to do to lease the property, and when. A shorter WALT means that you’ll need to work to find new tenants, and sooner.
Since leasing can be quite time-consuming work – and expensive work, if you have trouble finding tenants and part of the property is left vacant for a significant period – this information should factor into the pros and cons when you’re considering investing in a particular property.
Additional reasons to pay attention to a WALT figure include:
1.Cash Flow Stability and Predictability
Longer WALTs mean that a property has secured tenants who are committed to paying rent for a more extended period. For investors, this translates into a stable and predictable cash flow, which is ideal for meeting debt obligations and projecting reliable returns.
Properties with a longer WALT tend to be more attractive to conservative investors looking for stability, as the likelihood of sudden vacancies is low.
2.Lower Vacancy and Leasing Costs
When leases are set to expire in the distant future, property owners and investors face fewer near-term vacancy risks. The turnover costs associated with finding new tenants, refurbishing spaces, or adjusting lease terms are minimized. Additionally, long-term tenants are less likely to vacate as they have likely invested in outfitting the space to meet their needs.
3.Higher Property Values
Investors may observe that properties with longer WALTs generally command higher valuations. This is due to the perceived security of prolonged tenant commitment, which contributes positively to the net operating income (NOI) and therefor to the property’s overall value. Conversely, properties with shorter WALTs may suffer from valuation discounts, as their income potential is uncertain beyond the short term.
4.Better Financing Options and Terms
Properties with a strong WALT often enjoy better financing terms. Lenders view properties with stable, long-term income as less risky, which can lead to lower interest rates and more favorable loan-to-value (LTV) ratios. This financing advantage can enhance overall returns and boost investor leverage.
In contrast, properties with shorter WALTs may face challenges in securing financing or encounter higher interest rates, which can impact profitability. Ideally, lenders want to see terms that reflect the length of the fixed financing they are providing.
The Limitations of WALT
While WALT is a valuable metric, it does have its limitations. It doesn’t account for other aspects of tenant quality, such as creditworthiness or industry risk – which can affect a tenant’s ability to honor lease terms over the long haul. Additionally, WALT doesn’t account for diversification, meaning that if a single volatile tenant represents a large portion of the income, the property may still be vulnerable despite a high WALT.
Conclusion
For real estate investors, weighted average lease term provides a clear view into the income stability, risk, and potential value of an asset. Longer WALTs are typically more attractive, as they imply steady cash flows, lower vacancy risks, and favorable valuation and financing terms. However, investors should use WALTs in conjunction with other property-specific and tenant-specific metrics to form a comprehensive view of an asset’s quality and income stability.
Many investors we work with enjoy peace of mind knowing the properties we recommend for their portfolio are well-balanced and produce stable income. Do you have a commercial property in your portfolio that you need managed or leased? Our Commercial Property Management team is taking on new clients. Please contact us to discuss your commercial property’s options.
Sources
https://www.adventuresincre.com/glossary/weighted-average-lease-term/
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