Valuing and Pricing Retail Leases with Renewal and Overage Options

28 Pages Posted: 20 Sep 2002 Last revised: 7 Mar 2021

See all articles by Patric H. Hendershott

Patric H. Hendershott

University of Aberdeen - Centre for Property Research; National Bureau of Economic Research (NBER)

Charles W.R. Ward

University of Reading

Multiple version iconThere are 2 versions of this paper

Date Written: September 2002

Abstract

We consider retail leases with landlord overages options, with tenant renewal options, with both and with neither. We illustrate how the ratio of initial expected sales to the sales threshold can be manipulated to equate the value of the landlord overage options to that of the tenant renewal option at the same initial rent. As a result, not only are the values of the dual option overage plus renewal lease and no option leases are equal, but the cumulative distributions of potential IRRs on the two leases are nearly identical, suggesting that these leases are equally attractive to risk-adverse investors and thus that the same risky discount rate can be used in valuing the leases. The analysis is carried out in a risk-neutral framework, and sensitivity of the results to interest rate uncertainty, real sales volatility and growth, and the required risk premium on retail real estate is shown. The appropriate risky discount rate for the overage lease is calculated to be 75 to 160 basis points greater than that for the renewal lease.

Suggested Citation

Hendershott, Patric H. and Ward, Charles W.R., Valuing and Pricing Retail Leases with Renewal and Overage Options (September 2002). NBER Working Paper No. w9214, Available at SSRN: https://ssrn.com/abstract=332258

Patric H. Hendershott (Contact Author)

University of Aberdeen - Centre for Property Research ( email )

Aberdeen AB24 2UF
Scotland

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Charles W.R. Ward

University of Reading ( email )

ICMA Centre,
Henley Business School
Reading, RG6 6AB
United Kingdom
T: +44 (0)118 378 8239 (Phone)

HOME PAGE: http://www.icmacentre.ac.uk/about_us/academic_staff/professor_charles_ward,

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