Sustainable Value of Investment in Real Estate: Real Options Approach

Abstract

The issue of application of real option valuation approach in the valuation of investment project is presented in the article in a way in which the flexibility of the project could be included in the process of its valuation. The authors apply the valuation approach in case of a specific investment project in the real estate in the capital city of the Czech Republic—Prague, using the option to expand, to contract, and to abandon the project. The main aim of this case study is to present a practical application of the investment valuation and to construct an option pricing model for real estate investment which considers and integrates as many aspects of the investment and market environment as possible to describe the best situation of the real estate market and its development. The valuation of the investment is carried out using a universally applicable numerical method of binomial trees. The results obtained are subjected to the sensitivity analysis with respect to the discount rate, value of the most influential parameter of the volatility and the input option parameters. The results of the valuation of the project obtained using the real option approach are important mainly for the management of the company in the process of quantification of the present value of future investments. Implementation of managerial interventions enables for optimizing the value of the project not only in case of favourable development of the real estate market, but particularly in case of unfavourable development. Therefore, they are important in order to protect an investor from potential high losses. Finally, the valuation of these interventions increases the present value of the project, contributing to the decision of the corporate management regarding its implementation.

To Wait or Not to Wait? Use of the Flexibility to Postpone Investment Decisions in Theory and in Practice

“…Our study focuses on examining the investment decision-making process at the individual level. We join the emerging and promising stream of studies that utilize experimental laboratory designs to closely investigate decision-making behavior in a real options based mechanism [12][13][14][15][16][17]. By doing so, we contribute to the managerial literature regarding micro-foundations of investment decision-making under uncertainty.…”

“…In this journal, the use of real options has been discussed a number of times in connection with economic sustainability. Focus has been on economic evaluation in the context of public private partnerships [12][13][14], technology, research, and development investments [15,16], investment in real-estate [17], and environmental investments [18,19].…”

Investments in Pinus elliottii Engelm. Plantations: Real Options Analysis in Discrete Time

“…An abandonment option is only exercised if the gain is greater than the present value of expected cash flows until the end of the investment project's useful life [99]. Thus, real probabilities of the abandonment option being exercised were considerably higher for both investment projects (Figure 7), which demonstrated that, with greater probability, the value generated by projects' cash flows did not exceed the value of abandoning them.…”

“…In the project with land purchase, the low probability of exercising the option to expand (8%) explained why valuation was lower compared to the other options (Figure 6B). When indicating non-expansion, it means that the present value of the project's expected cash flows, if expanded, would not exceed the additional disbursement needed to finance the expansion [99]. This means that when the project has a negative value, it does not obtain any value from the option to expand.…”

Detecting Possible Reduction of the Housing Bubble in Korea for Different Residential Types and Regions

“…Also, the work of [30] incorporated put option pricing to determine whether the global real estate market was undervalued in 18 countries after the Asian financial crisis, whereas the work of [31] confirmed the undervalued real estate market in the 500 real estate categories in 19 countries through the put option. Furthermore, the works of [32,33] utilized the real option to discover the real estate bubble in Hong Kong and Thailand; the works of [34,35] assessed the appropriate level of land prices in Japan through real options and confirmed the existence of a bubble; and the work of [36] and that of [37] utilized the options approach to identify the real estate bubbles in Latvia and the Czech Republic, respectively. In summary, the options approach can reflect the uncertainty of real estate investors more effectively than the traditional discounted cash flow or net present value analysis [38,39].…”