Valuing options to renew at future market value: the case of commercial property leases

Jenny Jing Wang (), Jianfu Shen () and Frederik Pretorius ()
Additional contact information
Jenny Jing Wang: The University of Hong Kong
Jianfu Shen: The Hong Kong Polytechnic University
Frederik Pretorius: The University of Hong Kong

Financial Innovation, 2023, vol. 9, issue 1, 1-35

Abstract: Abstract In this study, we develop and empirically test a valuation model for a commonly encountered option in office leases: a tenant’s option to renew at future market rent (a fair market value) with lease termination as the maturity date. The model integrates decision analysis with real options analysis and market risk with private risks. “Option value” is defined as the private value of the option to either party pre-contract, while “option price” assumes a fair agreement between transacting parties and can be positive (rental premium paid) or negative (rental discount offered). Without manifest expectations, an analysis of a sample of office leases supports the model’s logic with price estimates in a practical range. The tenants’ option price/value is shown to have a negative relationship with the original/renewal lease term; conversely, the landlords’ option value is positively related to the original/renewal term. Comparative analyses show that transaction costs have a positive effect on tenants’ option value and on prices, while vacancy costs and the vacancy period are both positively related to the landlords’ option value and negatively related to price. Market rent is found to have a negative relationship with option price. Overall, this study provides a theoretical analysis and empirical tests of the value of a real option that allows option holders to renew/extend their contracts at a fair market value.

Keywords: Fair market value renewal; Commercial property leases; Real option; Valuation; Integrated method (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://link.springer.com/10.1186/s40854-023-00479-1 Abstract (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:spr:fininn:v:9:y:2023:i:1:d:10.1186_s40854-023-00479-1

Ordering information: This journal article can be ordered from
http://www.springer. ... nomics/journal/40589

DOI: 10.1186/s40854-023-00479-1

Access Statistics for this article

Financial Innovation is currently edited by J. Leon Zhao and Zongyi

More articles in Financial Innovation from Springer, Southwestern University of Finance and Economics
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().