Home • PRRES Inc. Journal • Read the Journal

Using Real Property Option Valuation Methods When Market Data is not Available

Author/s: John Van Der Hoek, Malgorzata Korolkiewicz

Date Published: 1/01/2012

Published in: Volume 18 - 2012 Issue 3 (pages 293 - 312)

Abstract

Titman (1985) famously applied optionality to derive the value of a vacant block of land then used as a car park at UCLA for which, in common with traditional property valuation approaches, a willing but not anxious buyer was assumed. However, what might the value of such a vacant block of land be in a property market downturn when willing but not anxious buyers are hesitant and there is an absence of comparable sales for reference? This paper applies concepts of optionality and indifference pricing to explore how such a vacant block of land might be considered relative to other, non-property asset classes to derive an assessment of value in the absence of an active property market.

Download Full Article

Download the Full Article PDF

14445921.2012.11104364.pdf 14445921.2012.11104364.pdf (276kB)

Keywords

Certainty Equivalents - Indifference Pricing - Real Property Options - Relative Pricing - Risk Measures

References

  • Alexander, C and Chen, X 2012, A general approach to real option valuation with applications to real estate investments, ICMA Centre Discussion Paper no. DP 2012–04, available at SSRN: http://ssrn.com/abstract=1990957.
  • Barrieu, P and El Karoui, N 2004, Optimal derivatives design under dynamic risk measures, Proceedings AMS, viewed 15 May 2012, http://finance. unige.ch//laboratoire/docsemin/Barrieu-El%20Karoui.pdf
  • Barrieu, P and El Karoui, N 2009, ‘Pricing, hedging and designing derivatives with risk measures’, in Carmona, R (ed.), Indifference pricing: theory and applications, Princeton University Press, Princeton, pp. 77–146
  • Capozza, DR and Sick, GA 1991, ‘Valuing long-term leases: the option to redevelop’, Journal of Real Estate Finance and Economics, Vol. 4, No. 2, pp. 209–233
  • Carmona, R (ed.) 2009, Indifference pricing: theory and applications, Princeton University Press, Princeton
  • Davis, MHA 1997, ‘Option pricing in incomplete markets’, in Dempster MAH and Pliska, SR (eds), Mathematics of derivative securities, Chicago University Press, Chicago, pp. 216–226
  • Dixit, AK and Pindyck, RS 1994, Investment under uncertainty, Princeton University Press, Princeton
  • Edge, P 2011, Stochastic discount factor and real options, working paper, viewed 15 May 2012, http://www.realoptions.org/papers2011/ 28.pdf.
  • Elliott, RJ and van der Hoek, J 2009, ‘Duality methods’, in Carmona, R (ed.), Indifference pricing: theory and applications, Princeton University Press, Princeton, pp. 321–386
  • Fõllmler, H and Schied, A 2004, Stochastic finance, Walter de Gruyter, Berlin.
  • Flores, NE 2003, ‘Conceptual framework for nonmarket valuation’, in Champ, PA, Boyle, KJ and Brown, TC (eds), A primer on nonmarket valuation, Kluwer Academic Publishers, pp. 27–58
  • Geltner, D 1989, ‘On the use of financial option price model to value and explain vacant urban land’, AREUEA Journal, Vol. 17, no. 2, pp. 142–158
  • Grenadier, SR 1995, ‘Valuing lease contracts: a real options approach’, Journal of Financial Economics, Vol. 38, No. 3, pp. 297–331
  • Henderson, V 2005, ‘Explicit solutions to an optimal portfolio choice problem with stochastic income’, Journal of Economic Dynamics and Control, Vol. 29, No. 7, pp. 1237–1266
  • Henderson, V and Hobson, D 2009, ‘Utility indifference pricing: an overview’, in Carmona, R (ed.), Indifference pricing: theory and applications, Princeton University Press, Princeton, pp. 44–74
  • International Valuation Standards Council 2011, International Valuation Standards, London
  • Johnston, M 2004, The stochastic discount factor for the exponential-utility capital asset pricing model, working paper, viewed 15 May 2012, http://www.asb.unsw.edu.au/schools/actuarialstudies/research/Pages/workingpapers.aspx?Year=2004
  • van der Hoek, J and Elliott, RJ 2005, Binomial models in finance, Springer Verlag, New York
  • Miao, J and Wang, N 2007, ‘Investment, consumption, and hedging under incomplete markets’, Journal of Financial Economics, Vol. 86, No. 3, pp. 608–642
  • Patel, K and Paxson, D 2001, ‘Real urban development options at Canary Wharf, in Newton, D, Paxson, D, Howell, S, Cavus, M, Stark, A and Pereira, J (eds), Real options: evaluating corporate investment opportunities in a dynamic world, Prentice Hall, Upper Saddle River, pp. 163–176.
  • Patel, K, Paxson, D and Sing, TF 2005, A review of the practical uses of real property options, RICS Research Paper Series, Vol. 5, No. 1
  • Titman, S 1985, ‘Urban land prices under uncertainty’, American Economic Review, Vol 75, No 3, pp. 505–514
  • Trigeorgis, L 1997, Real options. managerial flexibility and strategy in resource allocation, MIT Press, Cambridge.
  • Williams, JT 1991, ‘Real estate development as an option’, Journal of Real Estate Finance and Economics, Vol. 4, No. 2, pp. 191–208
  • Williams, JT 1993, ‘Equilibrium and options on real assets’, The Review of Financial Studies, Vol. 6, No. 4, pp. 825–850
  • Zariphopoulou, T 2001, ‘A solution approach to valuation with unhedgeable risks’, Finance and Stochastics, Vol. 5, No. 1, pp. 61–82