Pricing Short Leases And Break Clauses Using
Simulation Methodology
Patrick McAllister
Working Papers in Land Management and Development
11/00
pp. 21
Abstract
This
paper examines the changes in the length of commercial property leases
over the last decade and presents an analysis of the consequent investment
and occupational pricing implications for commercial property investmentsIt
is argued that the pricing implications of a short lease to an investor
are contingent upon the expected costs of the letting termination to the
investor, the probability that the letting will be terminated and the volatility
of rental values.The paper examines
the key factors influencing these variables and presents a framework for
incorporating their effects into pricing models.Approaches
to their valuation derived from option pricing are critically assessed. It
is argued that such models also tend to neglect the price effects of specific
risk factors such as tenant circumstances and the terms of break clause. Specific
risk factors have a significant bearing on the probability of letting termination
and on the level of the resultant financial losses.
The merits of a simulation methododology are examined for rental and
capital valuations of short leases and properties with break clauses.It
is concluded that in addition to the rigour of its internal logic, the
success of any methodology is predicated upon the accuracy of the inputs.The
lack of reliable data on patterns in, and incidence of, lease termination
and the lack of reliable time series of historic property performance limit
the efficacy of financial models.
To Main Menu