IDEAS home Printed from https://ideas.repec.org/a/gam/jsusta/v10y2018i12p4665-d188810.html
   My bibliography  Save this article

Sustainable Value of Investment in Real Estate: Real Options Approach

Author

Listed:
  • Marek Durica

    (Department of Quantitative Methods and Economic Informatics, Faculty of Operation and Economics of Transport and Communications, University of Zilina, Univerzitna 1, 010 26 Zilina, Slovakia
    These authors contributed equally to this work.)

  • Danuse Guttenova

    (Department of Quantitative Methods and Economic Informatics, Faculty of Operation and Economics of Transport and Communications, University of Zilina, Univerzitna 1, 010 26 Zilina, Slovakia
    These authors contributed equally to this work.)

  • Ludovit Pinda

    (Department of Mathematics and Actuarial Science, Faculty of Economics Informatics, University of Economics in Bratislava, Dolnozemska cesta 1, 852 35 Bratislava, Slovakia
    These authors contributed equally to this work.)

  • Lucia Svabova

    (Department of Economics, Faculty of Operation and Economics of Transport and Communications, University of Zilina, Univerzitna 1, 010 26 Zilina, Slovakia
    These authors contributed equally to this work.)

Abstract

The issue of application of real option valuation approach in the valuation of investment project is presented in the article in a way in which the flexibility of the project could be included in the process of its valuation. The authors apply the valuation approach in case of a specific investment project in the real estate in the capital city of the Czech Republic—Prague, using the option to expand, to contract, and to abandon the project. The main aim of this case study is to present a practical application of the investment valuation and to construct an option pricing model for real estate investment which considers and integrates as many aspects of the investment and market environment as possible to describe the best situation of the real estate market and its development. The valuation of the investment is carried out using a universally applicable numerical method of binomial trees. The results obtained are subjected to the sensitivity analysis with respect to the discount rate, value of the most influential parameter of the volatility and the input option parameters. The results of the valuation of the project obtained using the real option approach are important mainly for the management of the company in the process of quantification of the present value of future investments. Implementation of managerial interventions enables for optimizing the value of the project not only in case of favourable development of the real estate market, but particularly in case of unfavourable development. Therefore, they are important in order to protect an investor from potential high losses. Finally, the valuation of these interventions increases the present value of the project, contributing to the decision of the corporate management regarding its implementation.

Suggested Citation

  • Marek Durica & Danuse Guttenova & Ludovit Pinda & Lucia Svabova, 2018. "Sustainable Value of Investment in Real Estate: Real Options Approach," Sustainability, MDPI, vol. 10(12), pages 1-18, December.
    • Handle: RePEc:gam:jsusta:v:10:y:2018:i:12:p:4665-:d:188810
    as

    Download full text from publisher

    File URL: https://www.mdpi.com/2071-1050/10/12/4665/pdf
    Download Restriction: no
    File URL: https://www.mdpi.com/2071-1050/10/12/4665/
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Ansaripoor, Amir H. & Oliveira, Fernando S., 2018. "Flexible lease contracts in the fleet replacement problem with alternative fuel vehicles: A real-options approach," European Journal of Operational Research, Elsevier, vol. 266(1), pages 316-327.
    2. Luigi Ranieri & Giorgio Mossa & Roberta Pellegrino & Salvatore Digiesi, 2018. "Energy Recovery from the Organic Fraction of Municipal Solid Waste: A Real Options-Based Facility Assessment," Sustainability, MDPI, vol. 10(2), pages 1-15, January.
    3. Kyungwon Kim & Jae Wook Song, 2018. "Managing Bubbles in the Korean Real Estate Market: A Real Options Framework," Sustainability, MDPI, vol. 10(8), pages 1-25, August.
    4. Fleten, Stein-Erik & Haugom, Erik & Ullrich, Carl J., 2017. "The real options to shutdown, startup, and abandon: U.S. electricity industry evidence," Energy Economics, Elsevier, vol. 63(C), pages 1-12.
    5. Williams, Joseph T, 1991. "Real Estate Development as an Option," The Journal of Real Estate Finance and Economics, Springer, vol. 4(2), pages 191-208, June.
    6. Haehl, Christian & Spinler, Stefan, 2018. "Capacity expansion under regulatory uncertainty:A real options-based study in international container shipping," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 113(C), pages 75-93.
    7. Zmeskal, Zdenek, 2010. "Generalised soft binomial American real option pricing model (fuzzy-stochastic approach)," European Journal of Operational Research, Elsevier, vol. 207(2), pages 1096-1103, December.
    8. Rocha, Katia & Salles, Luciana & Garcia, Francisco Augusto Alcaraz & Sardinha, Jose A. & Teixeira, Jose P., 2007. "Real estate and real options -- A case study," Emerging Markets Review, Elsevier, vol. 8(1), pages 67-79, March.
    9. Luiz E. Brandão & James S. Dyer & Warren J. Hahn, 2005. "Using Binomial Decision Trees to Solve Real-Option Valuation Problems," Decision Analysis, INFORMS, vol. 2(2), pages 69-88, June.
    10. Yiqing Li & Weiguo Yang & Lixin Tian & Jie Yang, 2018. "An Evaluation of Investment in a PV Power Generation Project in the Gobi Desert Using a Real Options Model," Energies, MDPI, vol. 11(1), pages 1-16, January.
    11. Titman, Sheridan, 1985. "Urban Land Prices under Uncertainty," American Economic Review, American Economic Association, vol. 75(3), pages 505-514, June.
    12. Mingming Zhang & Dequn Zhou & Hao Ding & Jingliang Jin, 2016. "Biomass Power Generation Investment in China: A Real Options Evaluation," Sustainability, MDPI, vol. 8(6), pages 1-22, June.
    13. Jianfu Shen & Frederik Pretorius, 2013. "Binomial option pricing models for real estate development," Journal of Property Investment & Finance, Emerald Group Publishing Limited, vol. 31(5), pages 418-440, August.
    14. Williams, Joseph T, 1993. "Equilibrium and Options on Real Assets," The Review of Financial Studies, Society for Financial Studies, vol. 6(4), pages 825-850.
    15. Adam Borison, 2005. "Real Options Analysis: Where Are the Emperor's Clothes?," Journal of Applied Corporate Finance, Morgan Stanley, vol. 17(2), pages 17-31, March.
    16. Robert Grovenstein & James Kau & Henry Munneke, 2011. "Development Value: A Real Options Approach Using Empirical Data," The Journal of Real Estate Finance and Economics, Springer, vol. 43(3), pages 321-335, October.
    17. Tian, Lixin & Pan, Jianglai & Du, Ruijin & Li, Wenchao & Zhen, Zaili & Qibing, Gao, 2017. "The valuation of photovoltaic power generation under carbon market linkage based on real options," Applied Energy, Elsevier, vol. 201(C), pages 354-362.
    18. Kwabena Mintah & David Higgins & Judith Callanan & Ron Wakefield, 2017. "Staging option application to residential development: real options approach," International Journal of Housing Markets and Analysis, Emerald Group Publishing Limited, vol. 11(1), pages 101-116, December.
    19. Guofeng Ma & Qingjuan Du & Kedi Wang, 2018. "A Concession Period and Price Determination Model for PPP Projects: Based on Real Options and Risk Allocation," Sustainability, MDPI, vol. 10(3), pages 1-21, March.
    20. Quigg, Laura, 1993. "Empirical Testing of Real Option-Pricing Models," Journal of Finance, American Finance Association, vol. 48(2), pages 621-640, June.
    21. Reuter, Wolf Heinrich & Fuss, Sabine & Szolgayová, Jana & Obersteiner, Michael, 2012. "Investment in wind power and pumped storage in a real options model," Renewable and Sustainable Energy Reviews, Elsevier, vol. 16(4), pages 2242-2248.
    22. Fuss, Sabine & Szolgayová, Jana, 2010. "Fuel price and technological uncertainty in a real options model for electricity planning," Applied Energy, Elsevier, vol. 87(9), pages 2938-2944, September.
    23. Joseph T. Williams, 1997. "Redevelopment of Real Assets," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 25(3), pages 387-407, September.
    24. Moon, Yongma & Baran, Mesut, 2018. "Economic analysis of a residential PV system from the timing perspective: A real option model," Renewable Energy, Elsevier, vol. 125(C), pages 783-795.
    25. A. Steven Holland & Steven H. Ott & Timothy J. Riddiough, 2000. "The Role of Uncertainty in Investment: An Examination of Competing Investment Models Using Commercial Real Estate Data," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 28(1), pages 33-64.
    26. Xiao, Yi-bin & Fu, Xiaowen & Oum, Tae H. & Yan, Jia, 2017. "Modeling airport capacity choice with real options," Transportation Research Part B: Methodological, Elsevier, vol. 100(C), pages 93-114.
    27. Boomsma, Trine Krogh & Meade, Nigel & Fleten, Stein-Erik, 2012. "Renewable energy investments under different support schemes: A real options approach," European Journal of Operational Research, Elsevier, vol. 220(1), pages 225-237.
    28. Ming-Cheng WU & I-Cheng LIN & Yi-Ting HUANG & Chang-Rong, 2015. "Forecasting Prices Of Presale Houses: A Real Option Approach," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(1), pages 143-158, March.
    29. Cruz Rambaud, Salvador & Sánchez Pérez, Ana María, 2017. "The option to expand a project: its assessment with the binomial options pricing model," Operations Research Perspectives, Elsevier, vol. 4(C), pages 12-20.
    30. Dimakopoulou, Andriana G. & Pramatari, Katerina C. & Tsekrekos, Andrianos E., 2014. "Applying real options to IT investment evaluation: The case of radio frequency identification (RFID) technology in the supply chain," International Journal of Production Economics, Elsevier, vol. 156(C), pages 191-207.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Biancardi, Marta & Di Bari, Antonio & Villani, Giovanni, 2021. "R&D investment decision on smart cities: Energy sustainability and opportunity," Chaos, Solitons & Fractals, Elsevier, vol. 153(P2).
    2. Azzurra Morreale & Luigi Mittone & Thi-Thanh-Tam Vu & Mikael Collan, 2020. "To Wait or Not to Wait? Use of the Flexibility to Postpone Investment Decisions in Theory and in Practice," Sustainability, MDPI, vol. 12(8), pages 1-19, April.
    3. Ye Li & Clemens Kool & Peter-Jan Engelen, 2020. "Analyzing the Business Case for Hydrogen-Fuel Infrastructure Investments with Endogenous Demand in The Netherlands: A Real Options Approach," Sustainability, MDPI, vol. 12(13), pages 1-22, July.
    4. Antonio Di Bari, 2021. "A barrier real option approach to evaluate public–private partnership projects and prevent moral hazard," SN Business & Economics, Springer, vol. 1(3), pages 1-19, March.
    5. Kyungwon Kim & Jae Wook Song, 2020. "Detecting Possible Reduction of the Housing Bubble in Korea for Different Residential Types and Regions," Sustainability, MDPI, vol. 12(3), pages 1-31, February.
    6. Buso, Marco & Moretto, Michele & Zormpas, Dimitrios, 2021. "Excess returns in Public-Private Partnerships: Do governments pay too much?," Economic Modelling, Elsevier, vol. 102(C).
    7. Qüinny Soares Rocha & Rafaele Almeida Munis & Richardson Barbosa Gomes da Silva & Elí Wilfredo Zavaleta Aguilar & Danilo Simões, 2023. "Photovoltaic Solar Energy in Forest Nurseries: A Strategic Decision Based on Real Options Analysis," Sustainability, MDPI, vol. 15(5), pages 1-11, February.
    8. Antonio Di Bari, 2020. "A Real Options Approach to Valuate Solar Energy Investment with Public Authority Incentives: The Italian Case," Energies, MDPI, vol. 13(16), pages 1-15, August.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Kwabena Mintah, 2018. "Real Options Analysis in Residential Property Development Decision-Making in Australia: Perspective of Executives," International Real Estate Review, Global Social Science Institute, vol. 21(4), pages 473-520.
    2. d’Amato, Maurizio & Zrobek, Sabina & Renigier Bilozor, Malgorzata & Walacik, Marek & Mercadante, Giuseppe, 2019. "Valuing the effect of the change of zoning on underdeveloped land using fuzzy real option approach," Land Use Policy, Elsevier, vol. 86(C), pages 365-374.
    3. Clapp, John M. & Bardos, Katsiaryna Salavei & Wong, S.K., 2012. "Empirical estimation of the option premium for residential redevelopment," Regional Science and Urban Economics, Elsevier, vol. 42(1-2), pages 240-256.
    4. L. Li & Helen X. H. Bao & K. W. Chau, 2023. "On the Strategic Timing of Sales by Real Estate Developers: To Wait or To Presell?," The Journal of Real Estate Finance and Economics, Springer, vol. 66(1), pages 169-196, January.
    5. Gang‐Zhi Fan & Ming Pu & Tien Foo Sing & Xiaoyu Zhang, 2022. "Risk aversion and urban land development options," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 50(3), pages 767-788, September.
    6. Renigier-Biłozor Małgorzata & d’Amato Maurizio, 2017. "The Valuation of Hope Value for Real Estate Development," Real Estate Management and Valuation, Sciendo, vol. 25(2), pages 91-101, June.
    7. Rose Neng Lai & Lawrence Hoc Nang Fong, 2021. "Development Strategies in a Market of High Vacancies and Sticky Rates – The Case of the Hotel Industry," International Real Estate Review, Global Social Science Institute, vol. 24(3), pages 363-383.
    8. Bulan, Laarni & Mayer, Christopher & Somerville, C. Tsuriel, 2009. "Irreversible investment, real options, and competition: Evidence from real estate development," Journal of Urban Economics, Elsevier, vol. 65(3), pages 237-251, May.
    9. John Clapp & Katsiaryna Bardos & Tingyu Zhou, 2014. "Expansions and Contractions of Major US Shopping Centers," The Journal of Real Estate Finance and Economics, Springer, vol. 48(1), pages 16-56, January.
    10. Kyungwon Kim & Jae Wook Song, 2018. "Managing Bubbles in the Korean Real Estate Market: A Real Options Framework," Sustainability, MDPI, vol. 10(8), pages 1-25, August.
    11. Steven Ott & W. Hughen & Dustin Read, 2012. "Optimal Phasing and Inventory Decisions for Large-Scale Residential Development Projects," The Journal of Real Estate Finance and Economics, Springer, vol. 45(4), pages 888-918, November.
    12. Andrianos Tsekrekos & George Kanoutos, 2013. "Real Options Premia Implied from Recent Transactions in the Greek Real Estate Market," The Journal of Real Estate Finance and Economics, Springer, vol. 47(1), pages 152-168, July.
    13. Carlos Andrés Zapata Quimbayo, 2020. "OPCIONES REALES Una guía teórico-práctica para la valoración de inversiones bajo incertidumbre mediante modelos en tiempo discreto y simulación de Monte Carlo," Books, Universidad Externado de Colombia, Facultad de Finanzas, Gobierno y Relaciones Internacionales, number 138, August.
    14. Lu, Chien-Lin & Liao, Wen-Chi & Peng, Chien-Wen, 2020. "Developers’ perspectives on timing to build: Evidence from microdata of land acquisition and development," Journal of Housing Economics, Elsevier, vol. 49(C).
    15. Muhammad Zaim Razak & Haniza Khalid & Azhar Mohamad, 2018. "Speculative Behavior in Vacant Land Development: Evidence for Real Options in Malaysia," The Developing Economies, Institute of Developing Economies, vol. 56(4), pages 245-266, December.
    16. Couto, Gualter & Martins, Dulce & Pimentel, Pedro & Castanho, Rui Alexandre, 2021. "Investments on urban land valuation by real options – The Portuguese case," Land Use Policy, Elsevier, vol. 107(C).
    17. Sears, Joshua B., 2019. "A real options model of market entry: Endogenous uncertainty and exogenous uncertainty," Journal of International Management, Elsevier, vol. 25(3), pages 1-1.
    18. Ying Fan & Charles Ka Yui Leung & Zan Yang, 2022. "Financial conditions, local competition, and local market leaders: The case of real estate developers," Pacific Economic Review, Wiley Blackwell, vol. 27(2), pages 131-193, May.
    19. Zhang, Mingming & Liu, Liyun & Wang, Qunwei & Zhou, Dequn, 2020. "Valuing investment decisions of renewable energy projects considering changing volatility," Energy Economics, Elsevier, vol. 92(C).
    20. Huimin Yao & Frederik Pretorius, 2014. "Demand Uncertainty, Development Timing and Leasehold Land Valuation: Empirical Testing of Real Options in Residential Real Estate Development," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 42(4), pages 829-868, December.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:gam:jsusta:v:10:y:2018:i:12:p:4665-:d:188810. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: MDPI Indexing Manager (email available below). General contact details of provider: https://www.mdpi.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.