Cancellation Strategies in Commercial Real Estate Leasing

By Mooradian, Robert M.; Yang, Shiawee X. | Real Estate Economics, Spring 2000 | Go to article overview

Cancellation Strategies in Commercial Real Estate Leasing


Mooradian, Robert M., Yang, Shiawee X., Real Estate Economics


Robert M. Mooradian [*]

Shiawee X. Yang [*]

In a contractionary corporate environment, lease cancellation strategy becomes an important component of corporate real estate leasing decisions. This paper presents a leasing model in which less well-informed lessors offer leases with alternative lease cancellation options. The model demonstrates that a tenant's choice of cancellation option reveals his private information with respect to the likelihood of option exercise. Tenants who select a lease with a downsizing option are more likely to exercise the option. Given the higher likelihood of option exercise, the model suggests that the downsizing option will be priced higher. We examine a sample of 311 leases, and consistent with the model's prediction, we find that on average leases with a downsizing option have significantly higher contract rent. However, termination and sublet options are not associated with higher rent. The evidence suggests that market uncertainty, private information and adverse selection affect the pricing of alternative cancellatio n options and the choice of cancellation option.

Traditionally a corporate tenant with excess real property such as office space has had two possible courses of action, lease termination and subleasing. However, lease cancellation has become more complex than the conventional cancellation of the entire leased space. Many firms seek to reduce the amount of leased space rather than cancel the entire leased space. Accordingly, with increasing frequency corporate leases contain clauses permitting downsizing, i.e., leases include the option for the tenant to cancel a portion of the leased space.

This paper provides both theoretical and empirical analyses of the valuation of leases with cancellation options. The three potential courses of action for a tenant faced with the need to reduce the contracted space are subleasing, cancellation of the entire lease and downsizing. First, subleasing permits the transfer of the partial right of use to another lessee. However, in an economic downturn subleasing is likely to be unattractive to a tenant, who is less likely to be able to locate a sublessee. Second, the lessee can utilize the cancellation clause in the lease and then negotiate a new lease for a smaller space. If the real estate market is very weak, the lessee may be able to renegotiate on terms more favorable to her. Finally, a downsizing clause permits the tenant to return the unwanted fractional space to the lessor regardless of the market conditions.

In the model presented in this paper, landlords offer a menu of contracts containing the cancellation-related clauses such that the landlord is indifferent to the tenants' choice of contract. Landlords design contracts such that through the tenants' contract selection, landlords can infer the tenants' private information with respect to the probability of cancellation-related option exercise. In particular, landlords infer that tenants who select a lease containing a downsizing clause have a higher probability of option exercise.

The data we use to test the model are drawn from a sample of leases from the early 1990s, a period of weak real estate markets where a landlord is more likely to experience considerable losses when having to locate a new tenant following a tenant's decision to exercise a cancellation-related option. We empirically analyze the use of the three forms of options for a sample of 311 commercial leases of a large public company that is a lessee of a large amount of real estate across the U.S. The rent increments and possible penalties associated with downsizing, cancellation and subleasing clauses are compared. We find that leases containing downsizing clauses have significantly higher contract rent (controlling for the size of the leased space) than leases without any of the three cancellation-related clauses. Leases with only a downsizing clause have a monthly rent premium on average of $7,600 per property (controlling for the size of the rented space). …

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Cancellation Strategies in Commercial Real Estate Leasing
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.