In this paper, we combine direct arbitrage arguments and an option-pricing approach to develop a method of pricing the option for rent control. For a lump-sum payment of “key money,” a tenant acquires the right to rent a real estate unit for an exogenously determined controlled rent, as opposed to paying the free-market rent. The tenant may continue exercising this right as long as he or she lives. Alternatively, the tenant may sell the right to occupy the controlled rent unit and receive a fraction of the key money paid by the subsequent tenant. We value the equilibrium key money, in a representative agent's partial equilibrium, while endogenously determining the expected tenure duration in a controlled rent unit. We propose a procedure for valuing rent control options different from the representative agent's. Our analysis shows that under real-world levels of “conditional life expectancy,” the level of the fraction of the key money retained by a departing tenant has an insignificant effect on the expected tenure duration in a controlled rent unit and on the level of key money.
The Journal of Real Estate Finance and Economics – Springer Journals
Published: Oct 18, 2004
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