Bargaining, utility and rents: Analysing the effect of potential lease termination on rent negotiation outcomes

This paper analyses the effect of potential lease expiry on the rental negotiation process and levels of rental agreed. Several observers have noted that tenants may use the threat of lease termination at rental negotiations in order to obtain a rental and/or other concession. It is argued that it will often be rational for the landlord to make a rental concession in these circumstances and a model that identifies a theory‐forecasted concession level for landlords is developed. However, the bargaining process will often cause deviation from an equilibrium solution. The concession level of the landlord will be a function of four variables: expected landlord’s cost of void, probability of tenant relocation, landlord’s risk preference and the effects of the bargaining process. Utility theory is used to illustrate why the risk averse or risk neutral landlord in a potential lease termination situation will always maximise his/her utility by conceding an amount on the open market rental value provided that the landlord perceives the probability of lease termination to be greater than zero. However, although it is possible to identify a positive solution to the calculation of maximum concession, behavioural approaches to bargaining theory suggest that differences in individual negotiator’s attributes, social contexts and cognitive biases will also affect the outcome of a negotiated rent setting process.