Empirical Study on the Term Structure for Stockholm Commercial Property Leases

Abstract: Over recent years, the economic climate on the Swedish office market has been advantageous, and, as a result, both property prices and market rents have been on a constant rise for almost a decade. Moreover, an increased demand for flexibility in lease terms has been seen on the market, which begs the question; how would changing preferences in length of tenure affect rent levels? There exist several convincing theoretical cases that leases should yield different pricing dependent on its maturity and expectation about future market conditions. The conceptual framework developed by Grenadier (1995, 2005) has been used for the valuation of general leasing contracts and lease terms - applying an option-pricing approach. In total, three papers have analysed the effect length of tenure has on office equilibrium lease rates. However, the empirical evidence, to this date, has been inconclusive in its result when trying to isolate the effects. The purpose of this report is to investigate the relationship between rent and lease maturity. A hedonic pricing model will be developed, which allows for different shapes of the term structure curve, building on the model created by Gunnelin and Soderberg (2003), while controlling for price-relevant characteristics omitted in previous research – such as, building quality, quality of office premise, location, and tenant industry. The model will be used in an empirical study applied to commercial office contracts in Stockholm, Sweden, concluded between 2012 and 2019. The data used in the regression comprise of 1 508 office leases, contracted on the Stockholm market during the investigated period. The result showed a significant term structure for 4 out of 8 years for the full sample, and 5 out of 8 years for the subsample only including leases signed in the CBD. Concludingly, giving further evidence to the reasoning that the market adjusts the rents after lease length, according to future market expectations.