Investment Decision Commercial Real Estate Projects Based On Real Option

With the rapid development of the urbanization process in China, more and more developers join in the commercial real estate development market. More risks are discovered by developers. How to make rational investment decisions under uncertainty of the future is concerned by the commercial real estate developers most. Compared with the residential real estate, the commercial real estate investment project has three important characteristics:huge scale of investment, irreversibility and uncertainty. But the traditional discounted cash flow approach can’t give a reasonable explanation for them. The real options theory can be used to prove that uncertainty and irreversibility of the project can give the project flexible value.Based on the basic characteristics of commercial real estate project, in this paper, the project development process was regard as series of different kind of options. The framework of the commercial real estate project investment decisions making process are established after the matching of the uncertainty and options. Then the option model of defer investment is established. Based on the characteristics of commercial real estate market in China, the financing policy of the project is integrated into the model. The real option model on investment and financing interactive behavior of commercial real estate project under agency conflict of debt is established. According to the case calculations and comparative static analysis, both the direction and extent of the impact of decision variables and parameters on the project value and investment decision are analyzed.The main conclusions of the paper are as follows:Firstly, the commercial real estate investment project has three important characteristics:huge scale of investment, irreversibility and uncertainty. Based on the characteristics, developers can choose different strategies such as "learning by waiting" and "learning by doing" to get more information to reduce the uncertainty of the future. Then the real option analysis method is used to calculate the flexible value of the project. Secondly, different financing policies the developers adopt can affect the value of the project and the threshold of the investment decision. Because of the debt policies, principal-agent problem happened when the investment decision is making, which result in lower efficiency of investment. Finally, the increase of the market uncertainty and risk-free rate of interest can make developers to defer to investment. The increase of the lending rate will result in the increase of the financial risk and increase the threshold of the project fail.