Rental Expectations and the Term Structure of Lease Rates

We consider the term structure of lease rates in a general setting where both rents and interest rates are stochastic. The framework is applicable to any leasing market, but we focus on real estate. We find that the ``expectations hypothesis", that is, forward rates are unbiased estimators of future rents, requires similar assumptions as in interest rate theory to hold. To study bias magnitude, simulations are performed using a parameterization of the general framework. Different realistic values for risk aversion and interest rate stochastics can generate widely different shapes of the term structure, holding objective expectations constant. Thus an expected increase in rent is consistent with a downward-sloping term structure and vice versa.