The Use of Options Pricing to Value the Bare Dominium of Property with Long Leases

Abstract

Option pricing theory is familiar in the property market with studies that consider the methodology for the pricing of mortgages, development land, idle time, property stocks, lease options and other optionality with regard to design or use. It has not, to date, been generally considered as an alternative pricing method for income producing property as a financial investment. In this study, I investigate the use of options pricing theory to value long-term leases and provide a basis to deal with the uncertainty of future market changes that normally makes such valuation problematic. This has specific application to valuing the interests of the property owner in a property with a long-term land lease, whereby the income rights from the property are in the hands of the lease holder, also referred to as the bare dominium.