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The valuation of residential rental options with moving thresholds and transaction costs of moving

Fredrik Armerin () and Han-Suck Song ()
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Fredrik Armerin: Department of Real Estate and Construction Management, Royal Institute of Technology, Postal: , Teknikringen 10B, 100 44 Stockholm, Sweden
Han-Suck Song: Department of Real Estate and Construction Management, Royal Institute of Technology, Postal: Teknikringen 10B, 100 44 Stockholm, Sweden

No 19/10, Working Paper Series from Royal Institute of Technology, Department of Real Estate and Construction Management & Banking and Finance

Abstract: This paper develops a formula for pricing a residential option with respect to a tenant’s so called outside option. Two parameters are introduced: The tenant’s transaction cost of moving and moving threshold. The derived formula is then used to compute numerical examples of the option price for different parameter values. The pricing formula developed in this paper provides a useful way of conceptualizing and quantifying tenants’ transaction cost of moving, and moving threshold when they are considering to buy a residential option to hedge against strong market rent increases. The numerical examples show that the value of the option increases with higher transaction cost of moving, and decreases with higher moving threshold. With a low moving threshold (i.e. a liquidity constrained household) and/or a high transaction cost of moving, the rental option may have a high value for this household. This value might therefore be higher than the option value calculated the standard way, i.e. without the transaction cost of moving, and moving threshold parameters. The opposite situation occurs for a household with a high moving threshold and/or a low transaction cost of moving.

Keywords: rent regulation; rent control; rental option; real options; transaction costs (search for similar items in EconPapers)
JEL-codes: D18 R20 R31 R38 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2019-12-19
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