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Article: Binomial Option Pricing Models for Real Estate Development

TitleBinomial Option Pricing Models for Real Estate Development
Authors
KeywordsReal estate
Property finance
Option pricing
Real estate development
Institutional arrangement
Interactions
Financial constraint
Issue Date2013
Citation
Journal of Property Investment and Finance, 2013, v. 31 n. 5, p. 418-440 How to Cite?
AbstractPurpose – The purpose of this paper is to construct option pricing models for real estate development by considering and incorporating institutional arrangements, direct interactions and financial constraints in the model. It extends the application of real option theory from the framework borrowed from financial option pricing, and considers the case where a development company has restrictions from outside environment and financial constraint. It explores the effects of these additional practical factors on real asset project value and development timing. This paper makes contributions to bridge the theoretical models and practical applications. Design/methodology/approach – Real estate development is modelled in the binomial option pricing framework with the considerations of time-to-build, foregone rent if delaying, institutional environment and capital budgeting. The investment timings are derived from the models and sensitivity analysis is conducted to explore the effects of these factors. Findings – Apart from the factors in traditional option pricing theory, this paper confirms that the contractual covenants, positive synergies between properties and financial status of the firm, which enhance or restrict real flexibility embedded in the development land, influence project value and investment timing. Numerical examples illustrate the effects of these factors. It is argued that the valuation of real options should place emphasis on industry-specific characteristics and start from the perspective of the firm rather than individual options. Practical implications – The models constructed in this paper and the results can be directly used in the practical real estate development. Originality/value – This paper incorporates many practical factors in real estate development which are not investigated in previous studies. It values the option project from the firm perspective rather than project perspective as previous studies. It also shows the effects of institutional arrangement and firm factors on project value and development timing.
Persistent Identifierhttp://hdl.handle.net/10722/196120
ISSN
2015 SCImago Journal Rankings: 0.294

 

DC FieldValueLanguage
dc.contributor.authorShen, Jen_US
dc.contributor.authorPretorius, FIHen_US
dc.date.accessioned2014-03-28T07:40:26Z-
dc.date.available2014-03-28T07:40:26Z-
dc.date.issued2013en_US
dc.identifier.citationJournal of Property Investment and Finance, 2013, v. 31 n. 5, p. 418-440en_US
dc.identifier.issn1463-578X-
dc.identifier.urihttp://hdl.handle.net/10722/196120-
dc.description.abstractPurpose – The purpose of this paper is to construct option pricing models for real estate development by considering and incorporating institutional arrangements, direct interactions and financial constraints in the model. It extends the application of real option theory from the framework borrowed from financial option pricing, and considers the case where a development company has restrictions from outside environment and financial constraint. It explores the effects of these additional practical factors on real asset project value and development timing. This paper makes contributions to bridge the theoretical models and practical applications. Design/methodology/approach – Real estate development is modelled in the binomial option pricing framework with the considerations of time-to-build, foregone rent if delaying, institutional environment and capital budgeting. The investment timings are derived from the models and sensitivity analysis is conducted to explore the effects of these factors. Findings – Apart from the factors in traditional option pricing theory, this paper confirms that the contractual covenants, positive synergies between properties and financial status of the firm, which enhance or restrict real flexibility embedded in the development land, influence project value and investment timing. Numerical examples illustrate the effects of these factors. It is argued that the valuation of real options should place emphasis on industry-specific characteristics and start from the perspective of the firm rather than individual options. Practical implications – The models constructed in this paper and the results can be directly used in the practical real estate development. Originality/value – This paper incorporates many practical factors in real estate development which are not investigated in previous studies. It values the option project from the firm perspective rather than project perspective as previous studies. It also shows the effects of institutional arrangement and firm factors on project value and development timing.-
dc.languageengen_US
dc.relation.ispartofJournal of Property Investment and Financeen_US
dc.rightsCreative Commons: Attribution 3.0 Hong Kong License-
dc.subjectReal estate-
dc.subjectProperty finance-
dc.subjectOption pricing-
dc.subjectReal estate development-
dc.subjectInstitutional arrangement-
dc.subjectInteractions-
dc.subjectFinancial constraint-
dc.titleBinomial Option Pricing Models for Real Estate Developmenten_US
dc.typeArticleen_US
dc.identifier.emailPretorius, FIH: fredpre@hkucc.hku.hken_US
dc.identifier.authorityPretorius, FIH=rp01018en_US
dc.description.naturepostprint-
dc.identifier.doi10.1108/JPIF-10-2012-0046-
dc.identifier.scopuseid_2-s2.0-84880601939-
dc.identifier.volume31en_US
dc.identifier.issue5-
dc.identifier.spage418-
dc.identifier.epage440-

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