Journal of Real Estate Finance and Economics, 28:2/3, 273±292, 2004
# 2004 Kluwer Academic Publishers. Manufactured in The Netherlands.
Real Estate Rental Payments: Application of
Department of Economics, School of Business, The University of Reading, Whiteknights, Reading RG6 6AW,
Department of Real Estate and Planning, School of Business, The University of Reading, Whiteknights,
Reading RG6 6AW, U.K.
This paper analyzes the rental term structure taking into account the opportunity costs faced by the tenant for
varying lease lengths. The analysis involves the application of a multi-period stock inventory model. The
implication of the model is that the term structure of rents is determined by a clientele effect that can bias the
occupancy value derived from using rational-expectations in the term structure relationship. The model does,
however, reveal the characteristic stock-inventory U-shaped function that will determine the optimal lease length
for a given tenant.
Key Words: lease-lengths, term-structure, clientele
In observing commercial real estate leases, there may be considerable differences in the
contracts determining the length of tenure, the rent to be paid and the ¯exibility of
occupancy. Nevertheless, researchers have tried to develop models that explain the
relationship between, for example, length of tenure and the effective rent paid for
occupation. In some cases, this analysis has followed the contingent claims literature in
which the speci®c options inherent in the lease have been valued. In others a more static
framework has been used, referring to expectations of future occupancy costs and market
rental growth. Geltner and Miller (2001) assert that leasing strategy makes use of three
general principles: the equilibrium term structure of rents, the optimal lease term length
(involving a trade-off between releasing costs and ¯exibility) and speci®c factors arising
from conditions in submarkets. The purpose of this paper is to contribute to this analysis
by developing a model of rental term structure derived from a stock-inventory modelling
approach which can be used to illuminate the operation of the principles in determining
tenant choice in commercial leases.
The stock-inventory model may seem a curious source for analysis of rent
determination since historically its applications have been restricted to short-term asset
management. Much of the traditional treatment stems from the seminal work by Baumol
(1952) and Tobin (1956), which subsequently has been developed by authors such as