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Optimal Capital Structure in Real Estate Investment: A Real Options Approach

Author

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  • Jyh-Bang Jou

    () (School of Economics and Finance, Massey University (Albany))

Abstract

This article employs a real options approach to investigate the determinants of an optimal capital structure in real estate investment. An investor has the option to delay the purchase of an income-producing property because the investor incurs sunk transaction costs and receives stochastic rental income. At the date of purchase, the investor also chooses a loan-to-value ratio, which balances the tax shield benefit against the cost of debt financing resulting from a higher borrowing rate and a lower rental income. An increase in the sunk cost or the risk of investment will not affect the financing decision, but will delay investment. An increase in the income tax rate or a decrease in the depreciation allowance will encourage borrowing and delay investment, while an increase in the penalty from borrowing, a decrease in the investor's required rate of return, or worse real estate performance through borrowing, will discourage borrowing and delay investment.

Suggested Citation

  • Jyh-Bang Jou, 2011. "Optimal Capital Structure in Real Estate Investment: A Real Options Approach," International Real Estate Review, Asian Real Estate Society, vol. 14(1), pages 1-26.
  • Handle: RePEc:ire:issued:v:14:n:01:2011:p:1-26
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    More about this item

    Keywords

    Optimal Capital Structure; Real Estate Investment; Real Options; Transaction Costs;

    JEL classification:

    • L85 - Industrial Organization - - Industry Studies: Services - - - Real Estate Services

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