Working Paper Series,
Royal Institute of Technology, Department of Real Estate and Construction Management & Banking and Finance

Abstract: This paper develops a formula for pricing a residential option with respect to a tenant’s so called outside option. Two parameters are introduced: The tenant’s transaction cost of moving and moving threshold. The derived formula is then used to compute numerical examples of the option price for different parameter values. The pricing formula developed in this paper provides a useful way of conceptualizing and quantifying tenants’ transaction cost of moving, and moving threshold when they are considering to buy a residential option to hedge against strong market rent increases. The numerical examples show that the value of the option increases with higher transaction cost of moving, and decreases with higher moving threshold. With a low moving threshold (i.e. a liquidity constrained household) and/or a high transaction cost of moving, the rental option may have a high value for this household. This value might therefore be higher than the option value calculated the standard way, i.e. without the transaction cost of moving, and moving threshold parameters. The opposite situation occurs for a household with a high moving threshold and/or a low transaction cost of moving.

Keywords: rent regulation; rent control; rental option; real options; transaction costs

JEL-codes: D18; R20; R31; R38

28 pages, December 19, 2019

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