Combining Monte Carlo Simulations and Options to Manage the Risk of Real Estate Portfolios
This paper aims to show that the accuracy of real estate portfolio valuations can be improved through the simultaneous use of Monte Carlo simulations and options theory. Our method considers the options embedded in Continental European lease contracts drawn up with tenants who may move before the end of the contract. We combine Monte Carlo simulations for both market prices and rental values with an optional model that takes into account a rational tenant's behavior. We analyze to what extent the options exercised by the tenant significantly affect the owner's income. Our main findings are that simulated cash flows which take account of such options are more reliable that those usually computed by the traditional method of discounted cash flow. Moreover, this approach provides interesting metrics, such as the distribution of cash flows. The originality of this research lies in the possibility of taking the structure of the lease into account. In practice this model could be used by professionals to improve the relevance of their valuations: the output as a distribution of outcomes should be of interest to investors. However, some limitations are inherent to our model: these include the assumption of the rationality of tenant's decisions, and the difficulty of calibrating the model, given the lack of data. After a brief literature review of simulation methods used for real estate valuation, the paper describes the suggested simulation model, its main assumptions, and the incorporation of tenant's decisions regarding break options influencing the cash flows. Finally, using an empirical example, we analyze the sensitivity of the model to various parameters, test its robustness and note some limitations.
|Date of creation:||01 Jan 2011|
|Publication status:||Published in ESSEC Working paper. Document de Recherche ESSEC / Centre de Recherche de l'ESSEC ISSN : 1291-961.. 2011, pp.31|
|Note:||View the original document on HAL open archive server: https://hal-essec.archives-ouvertes.fr/hal-00671067|
|Contact details of provider:|| Web page: https://hal.archives-ouvertes.fr/|
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Elion Jani & Martin Hoesli & André Bender, 2005.
"Monte Carlo Simulations for Real Estate Valuation,"
eres2005_212, European Real Estate Society (ERES).
- Michel Baroni & Fabrice Barthélémy & Mahdi Mokrane, 2006.
"Optimal Holding Period In Real Estate Portfolio,"
eres2006_123, European Real Estate Society (ERES).
- Michel Baroni & Fabrice Barthélémy & Mahdi Mokrane, 2004.
"Physical Real Estate. A Paris Repeat Sales Residential Index,"
eres2004_105, European Real Estate Society (ERES).
- Baroni, Michel & Barthélémy, Fabrice & Mokrane, Mahdi, 2004. "Physical Real Estate: A Paris Repeat Sales Residential Index," ESSEC Working Papers DR 04007, ESSEC Research Center, ESSEC Business School.
- M. Baroni & F. Barthélémy & M. Mokrane, 2004. "Physical Real Estate: A Paris Repeat Sales Residential Index," THEMA Working Papers 2004-17, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
- Fabrice Barthélémy & Jean-Luc Prigent, 2008.
"Optimal Time to Sell in Real Estate Portfolio Management,"
THEMA Working Papers
2008-13, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
- Fabrice Barthélémy & Jean-Luc Prigent, 2009. "Optimal Time to Sell in Real Estate Portfolio Management," The Journal of Real Estate Finance and Economics, Springer, vol. 38(1), pages 59-87, January.
When requesting a correction, please mention this item's handle: RePEc:hal:journl:hal-00671067. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (CCSD)
If references are entirely missing, you can add them using this form.