A Note on Embedded Lease Options

Clapham, Eric

doi:10.1080/10835547.2003.12091112

Cited by 6 publications

(2 citation statements)

References 11 publications

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“…The benefit of avoiding the rental income loss may exceed the negative effect of transaction costs, and thus, the landlord's option value is shown to be greater in longer leases. Different renewal strike price assumptions yield different results than shown here; for example, Grenadier (1995) shows the premium of the option to renew at a fixed rent has a positive relationship with the renewal lease term, and Clapham (2003) shows that the term structure of the option premium for an indexed renewal option is hump-shaped. Both results are theoretical and not drawn from actual case applications and so are not directly comparable.…”

Section: Tenant and Landlord Option Prices And Option Valuesmentioning

confidence: 58%

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

2023

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

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Section: Tenant and Landlord Option Prices And Option Valuesmentioning

confidence: 58%

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

2023

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“…In agreement with the observations of Clapham (2003), one can question the ability of models based on real options to lend themselves to practical application in specific situations. Further heightening this doubt are at least two points of perplexity.…”

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confidence: 98%

Pricing the lease during the contract: an in‐progress approach to lease evaluation

Casellato

Nicolini

2009

Managerial Finance

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Purpose -Leasing evaluation is a subject that has drawn significant interest in economic circles for many years. The numerous models proposed in the literature have approached the topic from a variety of outlooks and approaches. The contributions made to date, however, all share what would appear to be an unwritten premise: namely, that leasing evaluation logically occurs prior to the start of the leasing relationship. The purpose of this paper is to eliminate this premise, in order to take an in-progress approach to the evaluation of leasing. Design/methodology/approach -The evaluation approach is based on a model that takes into account both the real factors (the market value of the asset) and the financial aspects of the lease (interest rates on the market). The leasing price is arrived at by taking the sum of: the advantage offered by the leasing, as compared to potential purchase of the asset on the spot market; and the added yield provided by the leasing, as compared to alternative investments. Findings -The paper finds that an in-progress approach allows measurement of the value of a leasing even if the lessor and the lessee have already decided to initiate the leasing relationship. This approach is called for when one of the parties (the lessor or the lessee) is replaced, as well as in cases where pathological situations lead to the interruption of the relationship, plus instances where it is necessary to carry out estimates for accounting purposes. The need to evaluate the leasing in terms of its different components (real and financial) also emerges from the instructions contained in the IAS17 regarding leasing. Originality/value -The contribution of the work to the leasing evaluation theme can be identified in a different perspective that can be useful both in a financial point of view and in an accounting one.

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