Real Options Analysis in Appraisal of Commercial Property Development

Purpose: This paper examined the application of real option analysis to real estate development (RED) appraisal in an emerging African market. It examined the effects of flexibility types on RED appraisal outcomes and compared the appraisal outputs with results obtained from the traditional NPV model.Design/methods: Using data of four case studies; three commercial and one residential property development, the study compared the results of the traditional NPV appraisal outputs under three scenarios of most optimistic, most likely and most pessimistic against the results obtained from the real option analysis using the Samuelson McKean Formula. The options examined were the option to delay/defer and vertically expand development.Findings: The results showed that the use of the DCF (NPV) traditional model favours a stable and optimistic market; with positive trends and forecast. Thus, during unanticipated market downturns, investors might be exposed to the greater level of downside risk when RED investments are appraised based on the traditional models only. This implies the needs to encourage the adoption of the real option models which guarantee better appraisal of RED investment even during the period of unexpected market downturns.Practical Implication: Based on evidences from an emerging market, the paper gives a further insight on the adoption real option analysis in RED appraisal in comparison with outputs obtained from the traditional DCF appraisal models.Originality: The paper is one of the few attempts that seek to demonstrate the practical application of real option analysis in practice, particularly from an emerging African market.