Real Option Valuation of Development land in Windhoek

Real option valuation has been viewed as a highly academic concept that has limited practical value because it focuses on valuing individual real options without providing a general theoretical framework. It may, however, not be denied that real options exist save for the fact that a universal conceptual framework is yet to be established. Real option reflects the entrepreneurial view of an investor of a project development’s flexibility and growth options and the active decisions embedded in a project rather than the traditional space, money and time triangle. By synthesising the characteristics of options attached to an investment opportunity, it is possible to estimate the value of inherent options attached to an investment opportunity. The objective of this paper is to establish whether or not there is option value in vacant development land in Windhoek, Namibia. The City of Windhoek municipality offers vacant development land for sale using open bidding for residential plots and sealed tender for commercial plots. The floor price is estimated at an assumed market value referred to as upset price which however is not revealed to the bidders. In an auction of commercial business and industrial plots conducted in July 2009, the bid/upset price ratio ranged from 1.7 to 11.2 with an average of 4.2. Since the bidders were not aware of the upset price and competing bids, it can be assumed that they acted independently and based their bid prices on the inherent option value of the investment opportunities in the plots. We investigate flexibility options to reduce, alter or delay project development. The purpose of this paper is to elaborate the real option concepts and demonstrate their application in practice contributing to enhancing real estate practioners’ critical thinking ability that will enable them determine the timing and level of development that can be undertaken under given circumstances. Using data from the period 2008/09, we examine the option to delay in four suburbs in Windhoek and consider densities of 1 dwelling per 200m2, and 1 dwelling per 350m2. We find real option value being prevalent in 1/200 densities in 3 of the 4 suburbs and no option value in 1/350 for all locations. We conclude that townhouse development in is more viable at 1/200 density.