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Long Term Ground Leases, the Redevelopment Option and Contract Incentives

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  • David Dale-Johnson

Abstract

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.

Suggested Citation

  • David Dale-Johnson, 1999. "Long Term Ground Leases, the Redevelopment Option and Contract Incentives," Working Paper 8653, USC Lusk Center for Real Estate.
  • Handle: RePEc:luk:wpaper:8653
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    File URL: http://lusk.usc.edu/sites/default/files/working_papers/wp_1999_115.pdf
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    References listed on IDEAS

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    1. Clarke, Harry R. & Reed, William J., 1988. "A stochastic analysis of land development timing and property valuation," Regional Science and Urban Economics, Elsevier, vol. 18(3), pages 357-381, August.
    2. Williams, Joseph T, 1993. "Equilibrium and Options on Real Assets," Review of Financial Studies, Society for Financial Studies, vol. 6(4), pages 825-850.
    3. Paul D. Childs & Timothy J. Riddiough & Alexander J. Triantis, 1996. "Mixed Uses and the Redevelopment Option," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 24(3), pages 317-339.
    4. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262100711.
    5. Joseph T. Williams, 1997. "Redevelopment of Real Assets," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 25(3), pages 387-407.
    6. Capozza, Dennis R & Sick, Gordon A, 1991. "Valuing Long-Term Leases: The Option to Redevelop," The Journal of Real Estate Finance and Economics, Springer, vol. 4(2), pages 209-223, June.
    7. Hart, Oliver, 1995. "Firms, Contracts, and Financial Structure," OUP Catalogue, Oxford University Press, number 9780198288817.
    8. Amin Kaushik & Capozza Dennis R., 1993. "Sequential Development," Journal of Urban Economics, Elsevier, vol. 34(2), pages 142-158, September.
    9. Titman, Sheridan, 1985. "Urban Land Prices under Uncertainty," American Economic Review, American Economic Association, vol. 75(3), pages 505-514, June.
    10. Williams, Joseph T, 1991. "Real Estate Development as an Option," The Journal of Real Estate Finance and Economics, Springer, vol. 4(2), pages 191-208, June.
    11. Capozza, Dennis R & Schwann, Gregory M, 1990. "The Value of Risk in Real Estate Markets," The Journal of Real Estate Finance and Economics, Springer, vol. 3(2), pages 117-140, June.
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