Real estate and other long-term development projects

Chapter 1 presents a model which attempts to identify the factors which contribute to the persistence of unanticipated demands shocks for the real estate market in general, as well as to explain why certain markets are more prone to boom and bust periods. The model analyzes the decisions which face market participants from the development phase through the operating phase of property management. During each stage the decision-maker is confronted with substantial demand uncertainty and adjustment costs. In addition, the construction stage may be characterized by long construction lags. These factors lead to two phenomena which help explain market persistence: (i) periods of overbuilding in which new properties enter the market during an unanticipated downturn, and (ii) the hysteresis effect during the operating phase in which owners are reluctant to allow for substantial occupancy changes unless demand is dramatically altered.; Chapter 2 provides an empirical test of the model of Chapter 1, using city-specific vacancy rates for the office, industrial and apartment markets. We find large (but significantly different) persistence in each market. For the downtown office market, 75% an unanticipated shock will be felt one year later. For the industrial and apartment markets the effects are 55% and 35%, respectively. The model is used to identify the factors which may lead to the significant observed differences in the markets' equilibrium characteristics.; The application of real options analysis to investment decisions is now part of a growing literature. Chapter 3 attempts to extend existing contributions by providing a framework for evaluating long-term development opportunities, and applying it to realistic investment environments. A long-term investment opportunity is defined as an irreversible commitment of resources to development, the payoff to which is uncertain in both timing and value. Potential applications to both corporate investment policy and real estate development are considered. The model is used to help explain the current glut of commercial real estate. Data is presented which broadly characterizes the historical movements in supply and demand in the office and industrial property markets. The model is then used to determine the factors which may lead to the increased likeihood of overbuilding.