A leasing spread is a measure of the difference between rent per square foot on a new lease, compared to the rent that was previously paid for the same space. There are a few ways to report leasing spreads.
First, spreads are usually differentiated between renewal leases, and leases signed to new tenants on vacant space. Generally speaking renewal spreads are less volatile because in place tenants are more likely to continue to pay the same rate.
The second differentiation is a bit more complicated, and has to do with the difference between GAAP rents, or the rents used to calculate top-line revenue, compared to cash rents, which is the actual cash received from the tenant in that reporting period. A typical long-term lease (more than one year) usually includes annual rent increase provisions, which means the rent paid in the first year is lower than the rent paid at the end of the lease. However, GAAP accounting requires that the rent over the whole lease term be averaged and that average number is used for the revenue line on the income statement. This means that GAAP rent is overstated in the early years of the lease and understated in the later years of the lease. With that in mind, in terms of leasing spreads, cash spreads measure the percent difference between actual cash rent paid in the first year of the new lease compared the actual cash rent paid in the last year of the prior lease. In contrast, GAAP leasing spreads measure the difference between the total lease term average rent of the new lease and the average rent of the old lease. Assuming the lease calls for rent increases on the new and old lease, then GAAP lease spreads should usually be higher than cash leasing spreads.
As always, it’s good to visualize the difference by using an example. In the spreadsheet below, we laid our the metrics for a six year lease, that started at $20 per square foot and increase by 2.5% per year and ended in year six at $22.63 per square foot. The starting cash rent was $20.00, and the ending cash rent was $22.63. However, GAAP require an average over the lease term, which we calculated as $21.29. The lease was renewed for an additional four year at a new starting cash rent of $25.00 per square foot, and increase by 2.5% per year up to $26.92 in year four. The average, GAAP, rent is $25.95. The cash lease spread would be calculated as the difference between the year one cash rent of the new lease ($25.00) and the final cash rent of the old lease ($22.63), which is 10.5%. The GAAP leasing spread is the difference between the average rents of both leases ($25.95 and $21.29), which is 21.9%.
Feel free to change the starting rents for both leases and the annual rent increase, and see how the leasing spreads are impacted.