Empirical estimation of the option premium for residential redevelopment

Abstract

This paper presents and validates a novel empirical approach for measuring the value of 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 positive option to redevelop, with a mean value of 29-34% for properties most like 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.

Estimating Land Development Time Lags in China Using DMSP/OLS Nighttime Light Image

“…Land banking as a business strategy has special importance to giant enterprises due to their monopolistic positions in the market. Clapp et al [8] treated the starting time of a development real estate as a Real Option (RO) in their study and found a positive relationship between the RO values of the development and the fluctuation of housing prices. Zhu's study [4] suggested that imperfect and ineffective laws and government regulations indirectly impel real estate developers to hoard land in China.…”

The Valuation of Hope Value for Real Estate Development

“…CUNNINGHAM (2007) demonstrates a negative correlation between real estate development and price uncertainty, and a positive correlation between property prices and uncertainty. CLAPP and SALAVEI (2010), CLAPP, JOU and LEE (2012), and CLAPP, SALAVEI and WONG (2012) included the redevelopment option value as separate from the value of the property inside a hedonic model. Furthermore, GROVENSTEIN et al (2011) improved QUIGG'S (1993) work using empirical data to calculate development cost elasticity.…”

Externalities of Urban Renewal: A Real Option Perspective

“…In particular, ∂(op on value)/∂H* > 0 and ∂(op on value)/∂H < 0. We add the title assembly cost, κ, to the strike price of the option term because unlike single-family houses analyzed by Clapp and Salavei (2010) and Clapp et al (2012), the redevelopment of multiple ownership apartment buildings would be impossible without assembling all or a majority 6 of the titles of apartment units in the first place. A higher κ would lower the option value and property price (i.e., ∂P/∂κ < 0).…”

“…We are particularly interested in comparing the external effects of urban renewal on newer and older buildings because the option value term in Eq. (2) becomes more important when a building ages (Clapp and Salavei, 2010;Clapp et al, 2012 …”

“…The real option theory adds that in addition to the current use value, existing buildings also carry a non-negative real option for the flexibility to redevelop into higher intensity or alternative uses (Clapp et al, 2007). As a building ages, its use value decreases, while its option value increases (Clapp and Salavei, 2010;Clapp et al, 2012). For multiple ownership buildings, this option value is also affected by the transaction cost of negotiation amongst owners of the units in the building.…”