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

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