Lease Maturity and Rent: Is There a Term Structure for UK Commercial Property Leases?

This paper investigates the relationship between lease maturity and rent in commercial property. Over the last decade market-led changes to lease structures, the threat of government intervention and the associated emergence of codes of practice for commercial leases have stimulated growing interest in pricing of commercial property leases. Seminal work by Grenadier (1995) derived a set of hypotheses about the pricing of different lease lengths in different market conditions. Drawing upon the explicit parallel with the term structure of interest rates, three possible term structure shapes were derived ñ downward-sloping, upward-sloping and singlehumped. Whilst there is a compelling theoretical case for and a strong intuitive expectation of differential pricing of different lease maturities, to date the empirical evidence is inconclusive. Two Swedish studies have found mixed results (Gunnelin and Soderbergh 2003 and Englund et al 2003). In only half the cases is the null hypothesis that lease length has no effect rejected. In the UK, Crosby et al (2003) report counterintuitive results. In some markets, they find that short lease terms are associated with low rents, whilst in others they are associated with high rents. Drawing upon a substantial database of commercial lettings in central London (West End and City of London) over the last decade, we investigate the relationship between rent and lease maturity. In particular, we test whether a building quality variable omitted in previous studies provides empirical results that are more consistent with the theoretical and intuitive a priori expectations.