Does the Theory of Irreversible Investments Help Explain Movements in Office–Commercial Construction?

Abstract

Focusing on the relevance of the modern investment theory in explaining movements in office–commercial construction, we attempt to advance existing empirical work in two respects. First, building on recent theoretical advances, we offer an extended empirical model of new construction that takes into account the full opportunity cost of irreversible investments in uncertain environments. Second, using updated time series of office–commercial construction across the nation's largest markets, we empirically estimate such a model to (i) explore investment behavior during 1982–1998 and (ii) detect differences, if any, in such behavior between the pre‐ and post‐recession years. Our empirical findings are fully consistent with the theory of irreversible investments. Such findings highlight both the relevance and the relative importance of uncertainty in underlying demand factors in shaping movements in office–commercial construction, while pointing altogether to more cautionary investment behavior during the post‐recession years.

Irreversible Investment, Real Options, and Competition: Evidence from Real Estate Development

“…2 Macroeconomic aggregate studies by Pindyck and Solimano (1993) and Caballero and Pindyck (1996) find a negative relationship between aggregate investment and uncertainty, where uncertainty is measured as the variance in the maximum observed marginal revenue product of capital. Other papers (Holland, Ott, and Riddough (2000), Sivitanidou and Sivitanides (2000), and Sing and Patel (2001)) examine this relationship specifically for real estate development, and usually, but not always, finding a negative relationship between uncertainty and development. Leahy and Whited (1996) Moel and Tufano (2002) examine the determinants of the decision to close or re-open a mine using a sample of 285 gold mines.…”

Making Energy-Efficiency and Productivity Investments in Commercial Buildings: Choice of Investment Models

“…Additionally, the long economic life of these assets will leave them producing their products long after a temporarily low price has been succeeded by an equally temporary high price. This focus on lengthier periods in large real assets does not imply that investors are uninterested in short-term fluctuations, because evidence from the commercial buildings sector alone reveals that investors are concerned about the timing of their investments so they are not coming on line with their durable asset just as a cyclical downturn is setting in (Sivitanidou and Sivitanides 2000;Bulan et al 2000;Holland et al 1995). Sing and Patel (2001) specified three stages of investment in the commercial property market (planning and development appraisal, construction, and institutional investment in the property), each offering different forms of real options to investors.…”

Time-To-Plan Lags for Commercial Construction Projects

“…For applications to commercial real estate, see Holland, Ott, and Riddiough (2000) and Sivitanidou and Sivitanides (2000). 4 For estimates of gestation lags from investment models, see Oliner, Rudebusch, and Sichel (1995), Zhou (2000), Koeva (2001), Millar (2005a), and Del Boca et al (2008); for estimates from dynamic factor demand models, see Palm, Peeters, and Pfann (1993) and Peeters (1998); and for estimates from business cycle models, see Altug (1989) and Christiano and Vigfusson (2003).…”