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Empirical estimation of the option premium for residential redevelopment

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  • Clapp, John M.
  • Bardos, Katsiaryna Salavei
  • Wong, S.K.

Abstract

This paper presents and validates a novel empirical approach for measuring the value of the option to redevelop using a standard hedonic dataset. Our analysis generalizes the standard hedonic model to account for the option value of reconfiguring hedonic characteristics. We test this model with over 162,000 real estate transactions in 53 towns in Connecticut between 1994 and 2007 by adding a non-linear intensity variable, which increases with the aggregate value of structure and decreases with land value. A conservative estimate is that about 20% of towns have significantly positive option value, with a mean value of 29–34% for properties most similar to vacant land. Multiple tests across towns support predictions of real options theory. Positive option value towns have higher house price volatility and estimated option value varies positively with price volatility, a finding inconsistent with NPV theory. We also find positive association between option value and drift in house prices and a U-shape relation with house price adjusted for structural characteristics. Higher property taxes reduce the value of option to redevelop.

Suggested Citation

  • 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.
    • Handle: RePEc:eee:regeco:v:42:y:2012:i:1:p:240-256
    DOI: 10.1016/j.regsciurbeco.2011.08.007
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    10. Anthony Yezer, 2016. "Testing the Association between Foreclosure and Nearby House Values: Can Differences Deceive?," Working Papers 2016-29, The George Washington University, Institute for International Economic Policy.
    11. Paul E. Carrillo & Anthony Yezer, 2021. "What Do Hedonic House Price Estimates Tell Us When Capitalization Rates Vary?," Working Papers 2021-03, The George Washington University, Institute for International Economic Policy.
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    13. Tirthatanmoy Das & Kabir Dasgupta, 2018. "Evaluating the Impact of Mothers' Self-esteem on Early Childhood Home Environment: Evidence from NLSY," Working Papers 2018-03 JEL Classificatio, Auckland University of Technology, Department of Economics, revised Oct 2019.
    14. 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.
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    16. Simon B chler, Alex van de Minne, Olivier Sch ni, 2020. "Redevelopment Option Value for Commercial Real Estate," Diskussionsschriften credresearchpaper26, Universitaet Bern, Departement Volkswirtschaft - CRED.
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    18. Sören Gröbel, 2018. "Regional heterogeneity in age-related housing depreciation rates [Regionale Heterogenität altersbedingter Wertminderungen von Wohnimmobilien]," Review of Regional Research: Jahrbuch für Regionalwissenschaft, Springer;Gesellschaft für Regionalforschung (GfR), vol. 38(2), pages 219-254, October.
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    More about this item

    Keywords

    Real options; Hedonic pricing; Housing redevelopment; House price volatility;
    All these keywords.

    JEL classification:

    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • D46 - Microeconomics - - Market Structure, Pricing, and Design - - - Value Theory
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • R31 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Housing Supply and Markets

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