Ostensibly the optimal leasing outcome for an office building would be to sign a whole-building tenant on a long lease. This, however, is not necessarily the case. The definition of ‘optimal’ is dependent on one’s required return and its composition, namely income and capital growth. Our modelling indicates there exists a trade-off between the two and that lease term is a contributing factor.
Market pricing (i.e. yield) of office buildings indicates that investors are willing to pay a premium for income, typically found in buildings with fewer tenants and a long WALE (weighted average lease expiry). But these buildings aren’t without risk in that large portions will fall vacant and / or there are large exposures to less predictable longer term market conditions. Our analysis suggests that realisation of those long-term risks can lead to a worse total return but, as evidenced by lower yields for long WALE assets, investors appear to value income certainty and their ability to manage leasing exposure and mitigate these risks.