Implicit Forward Rents as Predictors of Future Rents

Abstract

The paper investigates the relation between the term structure of rents and future spot rents. A rich database of office rental agreements for various maturities is used to estimate the term structure of rents, and from this structure implicit forward rents are extracted. The data pertain to commercial properties in the three largest Swedish cities for the period 1998-2002. A positive relation between forward and spot rents is found in some regions, but forward rents underestimate future rent levels. Another contribution of the paper lies in the area of rental index construction. We provide evidence that rental indices should not only be quality-constant (i.e. control for characteristics), but should also be maturity-constant.

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

“…While their research on three US metropolitan areas is performed on various property types and includes only 130 office leases, Stanton & Wallace (2009) find a positive and statistically significant relationship between lease length and rent. A similar conclusion is arrived at by Englund et al (2004) in their investigation of three Swedish office markets involving more than 4,000 lease contracts negotiated between 1998 and 2002. Gunnelin & Söderberg (2003) focus on the Stockholm CBD office market, with their study, performed over 15 years, being based on 1,300 leases.…”

“…Thus, doubling the term would raise the unit rent by 6.3%. Such a finding may seem quite surprising in light of the arguments developed by Kempf (2015, p. 95), Crosby et al (2003), McAllister (2001, Englund et al (2004) and Robinson (1999), all of which suggest that a negative relationship should prevail. The coefficient derived from the New York submarket is more in line with theoretical expectations as it is negatively signed.…”

“…Finally, findings from Webb & Fisher (1996) suggest that new tenants pay less rent than in-place tenants who are negotiating a renewal. Such findings though are at odds with both Englund et al (2004) and Gunnelin & Söderberg (2003) who find the opposite, with in-place tenants benefitting from a 4% to 10% rent discount over new ones.…”

“…In line with McCann & Ward (2004), findings from Crosby et al (2006) on the office market of England and Wales suggest that lease duration is dependent upon the size of the tenant organization, with small office tenants negotiating shorter lease terms for flexibility reasons while large and medium-size occupiers tend to prefer longer terms as they provide greater stability. Considering that leasing for longer periods reduces search costs, refurbishment costs, negotiation costs as well as occupancy risk for the landlord (Kempf, 2015, p.95) on top of enhancing capital values (Crosby et al, 2003), the tenant should be placed at an advantage over the landlord in the rent negotiation process, particularly in a recessionary context (McAllister, 2001;Englund et al, 2004). This argument is all the more sensible considering that, for the tenant, longer leases tend to reduce flexibility while raising capitalized liability (Robinson, 1999).…”

“…Regression findings though were not conclusive due to a low inflation period of analysis. Englund et al (2004) also tested for the impact of escalation clauses in their study on the Swedish office market. The dummy variables used emerged as statistically significant, which stems from the fact that the vast majority of Swedish leases are inflation-indexed.…”