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The valuation of residential rental options with moving thresholds and transaction costs of moving

Author

Listed:
  • Armerin, Fredrik

    (Department of Real Estate and Construction Management, Royal Institute of Technology)

  • Song, Han-Suck

    (Department of Real Estate and Construction Management, Royal Institute of Technology)

Abstract

This paper develops a formula for pricing a residential option with respect to a tenant’s so called outside option. Two parameters are introduced: The tenant’s transaction cost of moving and moving threshold. The derived formula is then used to compute numerical examples of the option price for different parameter values. The pricing formula developed in this paper provides a useful way of conceptualizing and quantifying tenants’ transaction cost of moving, and moving threshold when they are considering to buy a residential option to hedge against strong market rent increases. The numerical examples show that the value of the option increases with higher transaction cost of moving, and decreases with higher moving threshold. With a low moving threshold (i.e. a liquidity constrained household) and/or a high transaction cost of moving, the rental option may have a high value for this household. This value might therefore be higher than the option value calculated the standard way, i.e. without the transaction cost of moving, and moving threshold parameters. The opposite situation occurs for a household with a high moving threshold and/or a low transaction cost of moving.

Suggested Citation

  • Armerin, Fredrik & Song, Han-Suck, 2019. "The valuation of residential rental options with moving thresholds and transaction costs of moving," Working Paper Series 19/10, Royal Institute of Technology, Department of Real Estate and Construction Management & Banking and Finance.
    • Handle: RePEc:hhs:kthrec:2019_010
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    Citations

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    Cited by:

    1. Jenny Jing Wang & Jianfu Shen & Frederik Pretorius, 2023. "Valuing options to renew at future market value: the case of commercial property leases," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 9(1), pages 1-35, December.

    More about this item

    Keywords

    rent regulation; rent control; rental option; real options; transaction costs;
    All these keywords.

    JEL classification:

    • D18 - Microeconomics - - Household Behavior - - - Consumer Protection
    • R20 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - General
    • R31 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Housing Supply and Markets
    • R38 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Government Policy

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