The purpose of this article is to demonstrate the impact of lease duration and lease break options on the optimal holding period for a real estate asset or portfolio. The authors use a Monte Carlo simulation framework to simulate a real estate asset’s cash flows in which lease structures (rent, indexation pattern, overall lease duration and break options) are explicitly taken into account. The authors assume that a tenant exercises his/her option to break a lease if the rent paid is higher than the market rental value (MRV) of similar properties. The authors also model vacancy duration stochastically. Finally, capital values and MRVs, assumed to be correlated, are simulated using specific stochastic processes. The authors derive the optimal holding period for the asset as the value that maximizes its discounted value. The authors demonstrate that, consistent with existing capital markets literature and real estate business practice, break options in leases can dramatically alter optimal holding periods for real estate assets and, by extension, portfolios. The paper shows that, everything else being equal, shorter lease durations, higher MRV volatility, increasing negative rental reversion, higher vacancy duration, more break options, all tend to decrease the optimal holding period of a real estate asset.
BARONI, M., AMEDEE-MANESME, C.O., BARTHELEMY, F. and MOKRANE, M. (2015). The Impact of Lease Structures on the Optimal Holding Period For a Commercial Real Estate Portfolio. Journal of Property Investment and Finance, 33(2), pp. 121-139.