Commercial leases, terms and options in the light of game theory

Abstract

In this paper, we analyse the drivers of the office lease market with a particular emphasis on components such as lease duration and leased area as rent determinant. Using a leasing game, we built-up a conceptual framework to determine the terms of the leases -regarding duration, size of premises, conditions-negotiated between landlords and tenants. This model allows us to derive conclusions on the leasing market structure and in particular on bargaining power. In particular, we show why longer leases can command a premium under some market conditions. The conditions leading to opposite results are also discussed in the paper. Using data from Costar for New York City and Chicago, we discuss lease rates in light of our theoretical model. In particular, we find that, for both markets, the rent-size relationship is not monotonic but rather U-shaped, with unit rent, hence the premium to the landlord, rising beyond a given surface threshold.