FLEXIBILITY AND TENANT MIX IN REAL-ESTATE PROJECTS

This paper presents a model in which owners choose the optimal mix of tenants. Tenant types are broadly defined to include not only the stan dard distinctions (office, retail, industrial, residential), but also more subtle distinctions such as the nature of business (store type in shopping mall), preferences (high-quality versus no-frills), or degre e of credit risk. There are three key features of the model. First, re lative rent levels for different tenant types vary stochastically over time. Second, tenant demands for space are interrelated and may produ ce positive or negative externalities for other tenants. Third, alteri ng the current mix results in the payment of adjustment costs. Using t he methods of option pricing theory, the intertemporally optimal tenan t mix policy is derived and analyzed. In particular, several factors a re identified which impact the degree of landlord ''cautiousness'' in altering the current mix. Finally, the value of the optimal policy is decomposed into two forms of flexibility: dynamic flexibility emanatin g from the sequence of options to alter the mix in the future, and sta tic flexibility resulting from choosing an initial optimally diversifi ed ''portfolio'' of tenant types. (C) 1995 Academic Press, Inc.