Hostname: page-component-586b7cd67f-g8jcs Total loading time: 0 Render date: 2024-11-25T21:42:43.907Z Has data issue: false hasContentIssue false
  • English
  • Français

Lease Terms, Option Pricing and the Financial Characteristics of Property

Published online by Cambridge University Press:  10 June 2011

A.T. Adams ,
P.M. Booth  and
B.D. MacGregor
A.T. Adams
Affiliation:
The Management School, University of Edinburgh, William Robertson Building, 50 George Square, Edinburgh EH8 9JY, U.K., Tel: +44(0)131-650-3807, Fax: +44(0)131-668-3053, Email:[email protected]
Get access Rights & Permissions [Opens in a new window]

Abstract

Traditional and standard discounted cash flow valuation techniques are unable to deal with a variety of options contained in lease contracts. In the United Kingdom the most important embedded option is the upward-only rent review. This becomes more valuable to the landlord in an era of low demand and low inflation, as nominal market rents are more likely to fall. Lease contracts are freely negotiated between landlord and tenant, and alternative forms of rent review clause would fundamentally change the investment characteristics of property. Many other less common options also exist in lease contracts and these create further valuation difficulties. It is essential that property valuation techniques be developed that explicitly value the options in lease contracts.

Keywords

Property ValuationLease TermsUpward-Only Rent ReviewsOptions
Type
Sessional meetings: papers and abstracts of discussions
Information
British Actuarial Journal , Volume 9 , Issue 3 , 01 August 2003 , pp. 619 - 635
Copyright
Copyright © Institute and Faculty of Actuaries 2003

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Adams, A.T. & Booth, P.M. (1996). The appraisal of over-rented property. Journal of Property Finance, 7(3), 7–22.CrossRefGoogle Scholar
Ambrose, B.W., Hendershott, P.H., Klosek, M.M. & Buttimer, R.J. Jnr. (1999). Pricing upward-only leases. Paper presented to the first Property Economics and Finance Research Network Seminar, September.Google Scholar
Booth, P.M. (1993). Response to Department of the Environment consultation paper on commercial property leases (unpublished).Google Scholar
Booth, P.M. & Walsh, D.E.P. (1998). The application of financial theory to the valuation of upward only rent reviews. Actuarial research paper No. 117, The City University, London, England.Google Scholar
Booth, P.M. & Walsh, D.E.P. (2001)a. The application of financial theory to the pricing of upward only rent reviews. Journal of Property Research, 18(1), 69–83.CrossRefGoogle Scholar
Booth, P.M. & Walsh, D.E.P. (2001)b. An option pricing approach to valuing upward only rent review properties with multiple reviews. Insurance: Mathematics & Economics, 28, 151–171.Google Scholar
BPF/IPD (2002). Annual lease review 2001. IPD, London (availablefromwww.ipdindex.co.uk).Google Scholar
Brennan, M. & Schwartz, E. (1983). Determinants of GNMA mortgage prices. Journal of the American Real Estate and Urban Economics Association, 13, 209–228.CrossRefGoogle Scholar
Brown, R.L. & Achour, D. (1984). The pricing of land options. Urban Studies, 21, 317–323.CrossRefGoogle Scholar
Burton, J. (1992). Retail rents: fair and free market. Adam Smith Institute, London.Google Scholar
Childs, P.D., Ott, S.H. & Riddiough, T.J. (1996). The valuation of recourse and cross-default clauses in commercial mortgage contracting. Journal of Banking and Finance, 20, 51–136.CrossRefGoogle Scholar
Clarke, H.R. & Reed, W.J. (1988). A stochastic analysis of land development timing and property valuations. Regional Science and Urban Economics, 18, 357–381.CrossRefGoogle Scholar
Commercial Lease Group (2002). Code of practice for commercial leases in England and Wales. Commercial Lease Group, London, U.K.Google Scholar
Crosby, N., Baum, A. & Murdoch, S. (1993). Commercial property leases: a critical evaluation of Department of Environment proposals. Working papers in European Property, Centre for European Property Research, University of Reading.Google Scholar
Crosby, N., French, N.S. & Ward, C.W.R. (1997). Contemporary U.K. market valuation methods for over-rented investment properties: a framework for risk adjustment. Journal of Property Research, 14(2), 99–115.CrossRefGoogle Scholar
Davis, G.A. (1996). Option premiums in mineral asset pricing: are they important? Land Economics, 72(2), 167–186.CrossRefGoogle Scholar
Dunn, K.B. & McConnell, J.J. (1981a). A comparison of alternative models for pricing GNMA mortgage-backed securities. Journal of Finance, 36, 471–484.Google Scholar
Dunn, K.B. & McConnell, J.J. (1981)b. Valuation of GNMA mortgage-backed securities. Journal of Finance, 36, 599–616.Google Scholar
Gemmill, G., Matysiak, G.A. & Rodney, W. (1998). Valuing break clauses. Report prepared for Jones Lang Wootton, City University Business School.Google Scholar
Grenadier, S.R. (1995)a. The persistence of real estate cycles. Journal of Real Estate Finance and Economics, 10(2), 95–120.CrossRefGoogle Scholar
Grenadier, S.R. (1995)b. Valuing lease contracts: a real options approach. Journal of Financial Economics, 38, 297–331.CrossRefGoogle Scholar
Hairs, C.J., Belsham, D.J., Bryson, N.M., George, C.M., Hare, D.J.P., Smith, D.A. & Thompson, S. (2002). Fair valuation of liabilities. British Actuarial Journal, 8, 203–340.CrossRefGoogle Scholar
Hendershott, P.H. (1995). Real effective rent determination: evidence from the Sydney office market. Journal of Property Research, 12, 127–135.CrossRefGoogle Scholar
Hendershott, P.H. (1999). Increasing competition and competitiveness in the U.K. retail industry. Aberdeen Papers in Land Economy, 99-11, December.Google Scholar
Jarvis, S., Southall, F. & Varnell, E. (2001). Modern valuation techniques. Paper presented to the Staple Inn Actuarial Society, London.Google Scholar
Johnson, L.J. & Wofford, L.E. (1987). On contracts as options. Journal of the American Real Estate and Urban Economics Association, 15(1).CrossRefGoogle Scholar
Kau, J.B., Keenan, D.C. & Kim, T. (1993). Transaction costs, suboptimal termination and default probabilities. Journal of the American Real Estate and Urban Economics Association, 21(3), 247–263.CrossRefGoogle Scholar
Kau, J.B., Keenan, D.C., Muller, W.J. III & Epperson, J.F. (1987). The valuation and securitization of commercial and multifamily mortgages. Journal of Banking and Finance, 11, 525–546.CrossRefGoogle Scholar
Kau, J.B., Keenan, D.C., Muller, W.J. III & Epperson, J.F. (1990). The valuation and analysis of adjustable rate mortgages. Mnagement Sciences, 36, 1417–1431.Google Scholar
Kau, J.B., Keenan, D.C., Muller, W.J. III & Epperson, J.F. (1992). A generalised valuation model for fixed-rate residential mortgages. Journal of Money, Credit and Banking, 24, 279–299.CrossRefGoogle Scholar
Kau, J.B., Keenan, D.C., Muller, W.J. III & Epperson, J.F. (1993). Option theory and floating rate securities with a comparison of adjustable and fixed rate mortgages. The Journal of Business, 66(4), 595–618.CrossRefGoogle Scholar
Lentz, G.H. & Tse, K.S.M. (1995). An option-pricing approach to the valuation of real estate contaminated land with hazardous materials. The Journal of Real Estate Finance and Economics, 10(2), 121–144.CrossRefGoogle Scholar
Leung, W.K. & Sirmans, C.F. (1990). A lattice approach to fixed-rate mortgages with default and prepayments options. Journal of the American Real Estate and Urban Economics Association, 18, 91–104.CrossRefGoogle Scholar
Ling, D.C. (1993). Mortgage-backed futures and options. Journal of the American Real Estate and Urban Economics Association, 21(1), 47–67.CrossRefGoogle Scholar
Pemberton, J.M. (1997), Equity option valuation made simple and more reliable. Paper presented to the Staple Inn Actuarial Society, London.Google Scholar
Royal Instituition of Chartered Surveyors (2000). Leasing of business premises: review of the code of practice on commercial property leases in England and Wales. Letter to the Department of Environment, Transport and the Regions.Google Scholar
Shilling, J.D., Sirmans, C.F. & Benjamin, J.D. (1985). Contracts as options: some evidence from condominium developments. Journal of the American Real Estate and Urban Economics Association, 13(2), 143–152.CrossRefGoogle Scholar
Shilling, J.D., Sirmans, C.F. & Benjamin, J.D. (1987). On option-pricing models in real estate: a critique. Journal of the American Real Estate and Urban Economics Association, 15(1), 742–752.CrossRefGoogle Scholar
Titman, S. (1985). Urban land prices under uncertainty. The American Economic Review, 75(3), 505–513.Google Scholar
Titman, S. & Torous, W. (1989). Valuing commercial mortgages: an empirical investigation of the contingent claims approach to pricing risky debt. Journal of Finance, 44, 345–373.Google Scholar
Turnbull, G.K. & Sirmans, C.F. (1990). Vacant land options: a theoretical analysis. Regional Science and Urban Economics, 20, 213–222.CrossRefGoogle Scholar
Ward, C.W.R. & French, N.S. (1995). The arbitrage approach to valuation. Journal of Property Research, 12(1), 1–11.Google Scholar
Ward, C.W.R., Hendershott, P.H. & French, N.S. (1998). Pricing upward-only rent review clauses: an international perspective. Journal of Property Valuation and Investment, 16, 447–454.CrossRefGoogle Scholar