Valuing the effect of the change of zoning on underdeveloped land using fuzzy real option approach

Underdeveloped land may be subjected to changes in the land regulation system. In this case, the valuation process becomes difficult because of the uncertainty of inputs used in the valuation process. Land may be subject to changes in zoning and a property valuer may face the problem of determining the value of underdeveloped land affected by possible changes in land regulation. According to International Valuation Standards 2017, when appraising underdeveloped land, the valuer must take into account prospective changes in the planning system when defining highest and best use. Although this is a specific request of International Valuation Standards, a methodological problem remains and is particularly relevant in ‘thin’ markets. European Valuation Standards define thin markets as characterised by the fact that “…the number of possible comparables may be limited and few…” (European Valuation Standards, 2016, EVIP 2 Valuation Certainty and Market Risk, para 4.8) The paper proposes a methodology for dealing with such kind of real estate markets for property valuation purposes. To elaborate, empirical application in the urban area of Sassa near the city of L’Aquila in the southeast of Italy shows how this method may also be applied in real estate markets characterized by few observations and changing urban regulations. The proposed model uses binomial real option modelling (Cox et al., 1979). Among others, the model proposes a modification of the original Titman model for the valuation of underdeveloped land (Titman, 1985) This model is combined with possibility theory and fuzzy numbers in order to manage the uncertainty of sources of information. The valuation allows for defining a component of the value of the land that may be helpful in gaining a complete understanding of highest and best use determination.