Valuing renewal options in public industrial leases in Singapore

Option to review land rents to prevailing market rents and option to renew leases for another term are two important options embedded in the public industrial land leases in Singapore, managed by the Jurong Town Corporation (JTC). The land rents of JTC leases are reviewed every year subject to a cap on the land rent increase. The rent cap, which is historically lower than the prevailing market growth rate, widens the gap between the contract rent and the prevailing market rent as the lease progresses. This creates disincentives to the lessor for not exercising the rent review option, because the option is in‐the‐money. The rent gap, on the other hand, is also translated into substantial profit rents for lessees who hold onto the leasehold interests of industrial lands. By assuming two different probability distributions for the ex‐ante prevailing market rents, the profit rents were simulated to derive at the values of a hypothetical 30‐year lease, which range from US$47.93 (S$86.45) per square meter (psm) (Sungei Kadut, Kranji) to US$236.05 (S$425.74) psm (West Coast Highway). Based on these simulated 30‐year leasehold values and assumptions of other input parameters: equated yield (e = 10 percent), risk free rate (R_f = 4.52), volatility of leasehold value (σ = 15 percent), term of lease (T = 30 years) and rental growth cap (g = 7.6 percent), the premiums for the lease renewal options were estimated to be in a range of US$4.55 (S$8.21) psm to US$22.26 (S$40.15) psm.