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Combining Monte-Carlo Simulations and Options to manage Risk of Real Estate Portfolios. Amédée-Manesme Charles-Olivier, BNP Paribas Real Estate Investment Services Baroni Michel, Essec Business School Barthélémy Fabrice, THEMA, University of Cergy-Pontoise
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Amédée-Manesme Charles-Olivier, BNP Paribas Real Estate Investment Services
Baroni Michel, Essec Business School
Barthélémy Fabrice, THEMA, University of Cergy-Pontoise
Dupuy Etienne, BNP Paribas Real Estate Investment Services
At the time of a Break-Option the tenant has two possibilities:
At the time of a Break-Option the Landlord has no decision to take but can enter a negotiation
Rents usually indexed
Traditionally, tenants cannot negotiate the rent during the course of the contract whatever is the level of the Market rental value.
The owner of a call option has the right but not the obligation to buy an underlying asset at a predefined price K
The tenant of a European lease contract is the owner of an option: at the time of a break option, a tenant has the right but not the obligation to terminate the lease
A rational player will exercise its option at maturity as soon as it is “in the money”
St > K
The value of a European call at maturity is
A rational tenant will exercise its option to leave as soon as it is “in the money”
Rt > MRVt
By analogy, the value of a BO can be written:
The tenant vacates and the landlord has to find another tenant for a new rent. Given the necessary time to find a new tenant, the possible advantageous financial conditions granted by the landlord and the state of the market a void period corresponding to one year is applied in the cash-flow.
The tenant stays in the premises (same rent).
The tenant’s rent stands between the Market Rental Value and the Market Rental Value plus the transaction costs: in this case we consider both the tenant and the landlord adopt a rational behaviour and start negotiating. For simplification we consider they will concord to the market rental value.
two break-options are exercised
16Net operating income with our model for one scenario
For the owners, risk concentrated in the lease structure
The inflows received are based on the rents indexed and not on the market rental values, the rents can be overvalued or undervalued
A fixed 10 year lease is “safer” than a 10 years lease with an option to break at the fifth year.
Likely to cause vacancy Risk
averaging results from a large number of samples to provide meaningful results
Together correlated with a fixed correlation parameter
We do not need to value the premium of the option
We only need to estimate if the option will be exercised or not
Therefore at the time of a break-option each simulated Market Rental Value will be compared to the rents and the best tenant’s rational decision will be taken