The Optimal Holding Period for a Commercial Real Estate Portfolio: Taking the Lease Structure into Account

Fabrice Barthélémy ()

No 2014-30, THEMA Working Papers from THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise

Abstract: Purpose The purpose of this paper is to determine an optimal holding period for a real estate portfolio when break-options are included in the leases. Methodology/approach Optimization is achieved by maximizing the portfolio value, which is considered to be the sum of the discounted free cash flows and the discounted terminal value. The terminal value and the market rental value are simulated by a stochastic process representing a real estate index. To model the recurrent cash-flows, the lease structure of the portfolio and the behaviour of the tenant must be taken into account. A unit of real estate is vacated by a tenant if its current rent is too high in comparison with the market rental value available for similar properties. Vacant spaces remain unused for a period of time that is estimated using Poisson’s law. Findings We demonstrate that consideration of the break-options included in leases modifies the optimal holding period for a real estate fund. We show how factors included in the model influence the optimal time at which to sell the portfolio. Practical implications Practitioners are offered a practical methodology for determining the optimal best holding period for a portfolio or for a property. Originality/value The originality of the paper derives from considering the possibility that a tenant might move, which would modify the cash flows. This is critical in real estate portfolio management, because such specific risk is difficult to diversify.

Keywords: Real estate; Portfolio management; Simulation; Optimal time to sell (search for similar items in EconPapers)
Date: 2014
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