Long Term Ground Leases, the Redevelopment Option and Contract Incentives

Since the option to redevelop a property is valuable, ground leased property should trade at adiscount relative to fee simple property because of the impairment of the value of that optionresulting from the foreshortened horizon of the leaseholder. This discount would be over andabove the discount that results from the leaseholder’s non-existent residual claim to the property.We evaluate alternative contractual arrangements that may be more incentive compatible betweenthe owner of the leased fee and the leasehold. We find that a lease extension clause causes thelessee to defer development and develop at much higher density. Sharing of the value of theresidual claim between the owner of the leased fee and the leasehold also increases the intensityof redevelopment but results in earlier redevelopment. Also, we find that a more realisticescalation clause causes redevelopment to occur sooner but at similar density.