Real Options Model In Real Estate Development

There are many uncertainties in the process of real estate development. How to make the decision under uncertainty is the matter that developers care about. Real option approach, which is such a method that can help investor to make the decision under uncertainty, has been applied to the research about real estate development decision-making abroad and has become the foreland about real estate investment theory study. This paper based on the researches before, combining with the character of real estate development, studies the real estate development decision-making in-depth. The aim of the paper is to promote the application of real option method in real estate and improve the validity of real estate investment decision-making.First extending theory models using the dynamic programming in research, the uncertainty of cost and the building time are considered in the model. The change in opportunity to invest and the influence of discounted rate, variance and increment rate of price etc. are analyzed in theory. The critical value for development, namely the ratio of value to cost in the optimal time of development, is regarded as the basis of choosing development. Over and above this critical value, the development is valid. Then the log-transformed binomial lattice extension for two-dimensional option problems is selected as the numerical computing method and the computing model is set up using MATLAB software programme. Finally, empirical study is made using the parameters acquired from the house price index and construction cost index in Hong Kong and the theory model is validated by numerical solution and parameter analysis. One-off investment model is extended to a general multistage investment model and the mutual influences of multiple options are analyzed.Via the theory study, we find that while considering the uncertainty in price and cost both, it is the increase of synthesize variance but not the single variance results in the increasing of critical value. After considering the building time, decrease in discounted rate, increase in increment rate of price and decrease in change rate of cost would all increase the value of the option, but at the same time cause the increase in NPV. If the influence of parameter to former is larger than the latter, the critical value would increase vice versa. The numerical solution of empirical study suggests that the value of option in real estate investment can't be ignored. Moreover the empirical study open out that if the flexibility in building process is increased, the value of defer option would be weakened and the critical value would be decreased. These results would help investor not only to determine the optimal time of development and maximize the investment value, but also to analyze and impose the flexibility in development with reason and efficiency.