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Pricing Upward-Only Adjusting Leases

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  • Ambrose, Brent W
  • Hendershott, Patric H
  • Klosek, Malgorzata

Abstract

This paper presents a stochastic pricing model of a unique, path-dependent lease instrument common in the United Kingdom and numerous commonwealth countries, the upward-only adjusting lease. In this lease, the rental rate is fixed at lease commencement but will be reset to the market rate at predetermined intervals (usually every five years) if it exceeds the contract rent. We derive a closed form expression for the market rent of a lease with upward-only adjustments. Results indicate what the initial coupon rate on a 10-year lease with one reset should be relative to that on a symmetric up-and-downward adjusting "variable rate" lease under various economic conditions (level of real interest rates and expected drift and volatility of the underlying rental service flow). We also consider the calculation of effective rents when free rent periods are given. Copyright 2002 by Kluwer Academic Publishers

Suggested Citation

  • Ambrose, Brent W & Hendershott, Patric H & Klosek, Malgorzata, 2002. "Pricing Upward-Only Adjusting Leases," The Journal of Real Estate Finance and Economics, Springer, vol. 25(1), pages 33-49, July.
    • Handle: RePEc:kap:jrefec:v:25:y:2002:i:1:p:33-49
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    References listed on IDEAS

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    1. Grenadier, Steven R., 1995. "Valuing lease contracts A real-options approach," Journal of Financial Economics, Elsevier, vol. 38(3), pages 297-331, July.
    2. Miller, Merton H & Upton, Charles W, 1976. "Leasing, Buying, and the Cost of Capital Services," Journal of Finance, American Finance Association, vol. 31(3), pages 761-786, June.
    3. McConnell, John J. & Schallheim, James S., 1983. "Valuation of asset leasing contracts," Journal of Financial Economics, Elsevier, vol. 12(2), pages 237-261, August.
    4. Patric H. Hendershott & Colin M. Lizieri & George A. Matysiak, 1999. "The Workings of the London Office Market," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 27(2), pages 365-387, June.
    5. Cox, John C. & Ross, Stephen A., 1976. "The valuation of options for alternative stochastic processes," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 145-166.
    6. Grenadier, Steven R., 1996. "Leasing and credit risk," Journal of Financial Economics, Elsevier, vol. 42(3), pages 333-364, November.
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    Cited by:

    1. Ahmed Al sharif & Ruwen Qin, 2015. "Double-sided price adjustment flexibility with a preemptive right to exercise," Annals of Operations Research, Springer, vol. 226(1), pages 29-50, March.
    2. Franz Fuerst & Patrick McAllister, 2008. "Green Noise or Green Value? Measuring the Price Effects of Environmental Certification in Commercial Buildings," Real Estate & Planning Working Papers rep-wp2008-09, Henley Business School, University of Reading.
    3. Jonathan A. Wiley, 2014. "Gross Lease Premiums," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 42(3), pages 606-626, September.
    4. Brent Ambrose & Yildiray Yildirim, 2008. "Credit Risk and the Term Structure of Lease Rates: A Reduced Form Approach," The Journal of Real Estate Finance and Economics, Springer, vol. 37(3), pages 281-298, October.
    5. Neil Crosby & Virginia Gibson & Sandi Murdoch, 2003. "UK Commercial Property Lease Structures: Landlord and Tenant Mismatch," Urban Studies, Urban Studies Journal Limited, vol. 40(8), pages 1487-1516, July.
    6. Steven R. Grenadier, 2003. "An Equilibrium Analysis of Real Estate," NBER Working Papers 9475, National Bureau of Economic Research, Inc.
    7. Shaun Bond & Pavlos Loizou & Patrick McAllister, 2008. "Lease Maturity and Initial Rent: Is There a Term Structure for UK Commercial Property Leases?," The Journal of Real Estate Finance and Economics, Springer, vol. 36(4), pages 451-469, May.
    8. Fang Fang & Lu Ruichang, 2009. "Is There a Term Structure? Empirical Evidence from Shanghai Office Rental Market," International Real Estate Review, Global Social Science Institute, vol. 12(1), pages 23-38.
    9. Jenny Jing Wang & Jianfu Shen & Frederik Pretorius, 2023. "Valuing options to renew at future market value: the case of commercial property leases," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 9(1), pages 1-35, December.
    10. Richard Stanton & Nancy Wallace, 2009. "An Empirical Test of a Contingent Claims Lease Valuation Model," Journal of Real Estate Research, American Real Estate Society, vol. 31(1), pages 1-26.
    11. Chuang-Chang Chang & Hsiao-Wei Ho & Henry Hongren Huang & Yildiray Yildirim, 2024. "A reduced-form model for lease contract valuation with embedded options," Review of Quantitative Finance and Accounting, Springer, vol. 62(2), pages 841-864, February.
    12. Patric H. Hendershott & Robert J. Hendershott & Charles R. W. Ward, 2003. "Corporate Equity and Commercial Property Market 'Bubbles'," Urban Studies, Urban Studies Journal Limited, vol. 40(5-6), pages 993-1009, May.
    13. Fan, Gang-Zhi & Pu, Ming & Deng, Xiaoying & Ong, Seow Eng, 2018. "Optimal portfolio choices and the determination of housing rents under housing market uncertainty," Journal of Housing Economics, Elsevier, vol. 41(C), pages 200-217.

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    More about this item

    JEL classification:

    • R0 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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