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Market-Based Solutions to Vital Economic Issues
Research
Dec 1, 2020

The Term Structure of Real Estate Lease Contracts

Abstract

In financial markets, forward contracts reflect market perception of future price dynamics. Nontransparent markets, like commercial real estate investments, lack such tools. We use a panel of NYC office leases between 2005 and 2016 to estimate a dynamic term structure of forward lease rates (rental revenues), which reflects changing expectations by tenants and landlords about future rental contract conditions. Our imputed term structure is time-varying, generally upward-sloping, and often exhibits an inverted-U shape. We also find that shocks to forward lease rate dynamics are initially most keenly felt in the long-dated lease market and are subsequently transmitted to the short-term lease market. Moreover, consistent with an inefficient informational market, the leasing market takes multiple quarters to fully price the impact of an unanticipated event. Beyond shedding new light on rental market dynamics, our model can be used to quantify risk and reward for real estate strategies. To illustrate this, we examine the financial viability of a nascent “long”-“short” space market strategy commonly used by coworking providers in the last business cycle.


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