Commercial Real Estate Market Property Level Capital Expenditures: An Options Analysis

Option pricing theory predicts that capital improvement expenditures are positively linked with high or increasing market lease rates. Ceteris paribus, when the market lease rate is high, or when there is an expectation of higher lease rates in the future, owners are encouraged to increase investmen...

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Bibliographic Details
Published in:The journal of real estate finance and economics 2019-10, Vol.59 (3), p.372-390
Main Authors: Bond, Shaun A., Shilling, James D., Wurtzebach, Charles H.
Format: Article
Language:English
Subjects:
Capital expenditures
Cash flow
Commercial real estate
Economics
Economics and Finance
Expenditures
Financial Services
Industrial space
Leases
Owners
Real estate
Regional/Spatial Science
Skewness
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Summary:Option pricing theory predicts that capital improvement expenditures are positively linked with high or increasing market lease rates. Ceteris paribus, when the market lease rate is high, or when there is an expectation of higher lease rates in the future, owners are encouraged to increase investment to capture a larger profit. In contrast, when the market lease rate is low, or when there is an expectation of lower lease rates in the future, owners are encouraged to defer capital improvements, causing a skewness in the cash flows. Our empirical results generally support the notion that normal levels of capital expenditures not only maintain value but also actually may create value.
ISSN:0895-5638
1573-045X
DOI:10.1007/s11146-018-9680-1