Valuing and Pricing Retail Leases with Renewal and Overage Options

Patric Hendershott and Charles Ward

No 9214, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We consider retail leases with landlord overages options, with tenant renewal options, with both and with neither. We illustrate how the ratio of initial expected sales to the sales threshold can be manipulated to equate the value of the landlord overage options to that of the tenant renewal option at the same initial rent. As a result, not only are the values of the dual option overage plus renewal lease and no option leases are equal, but the cumulative distributions of potential IRRs on the two leases are nearly identical, suggesting that these leases are equally attractive to risk-adverse investors and thus that the same risky discount rate can be used in valuing the leases. The analysis is carried out in a risk-neutral framework, and sensitivity of the results to interest rate uncertainty, real sales volatility and growth, and the required risk premium on retail real estate is shown. The appropriate risky discount rate for the overage lease is calculated to be 75 to 160 basis points greater than that for the renewal lease.

JEL-codes: G0 G3 (search for similar items in EconPapers)
Date: 2002-09
New Economics Papers: this item is included in nep-rmg
Note: AP
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Citations: View citations in EconPapers (3)

Published as Hendershott, Patric H. and Charles W. R. Ward. "Valuing And Pricing Retail Leases With Renewal And Overage Options," Journal of Real Estate Finance and Economics, 2003, v26(2-3,Mar), 223-240.

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