A Term Structure of Commercial Lease Real Estate Returns

Abstract

Over the last decade, there has been considerable interest in the fundamental economics and finance of commercial real estate leases, following theoretical work on the economics of a term structure of lease rates and returns, the gametheoretical context within which lease rates are determined, and the economic nature of lease transactions as financial contracts. There has also been practical interest in the characteristics of leases as financial contracts from the viewpoint of asset-liability management. Unlike the term structure of interest rates, there is little empirical evidence of lease return term structure phenomena, primarily because extremely complex data requirements have conspired against the construction of an actual term structure of lease returns at any time. This has thus also limited the conduct of empirical tests of advances in commercial real estate lease research with actual lease returns term structure data. This paper reports on research towards abstracting an ex-post term structure of commercial lease returns from analysis of a sample of some four hundred office lease transactions over a five year timeframe. Following a detailed and time-intensive analysis of lease contracts, transaction-based office capital and rental indices and associated aggregate financial markets data, we construct an ex-post term structure of lease rates in a series of cross-sectional analyses using regression methodology. We find qualified support for a generally negative underlying term structure of lease returns following an agency cost hypothesis. In all, this paper demonstrates the unfortunate complexity and labour-intensity of research into phenomena underlying the credit contract nature of leases, and highlights problems with establishing a capital markets role for commercial real estate lease contracts comparable to that of debt contracts.