Flexibility in Real Estate Investment

Flexibility in Real Estate Investment Markus M. Harder Clare Hall Judge Business School University of Cambridge A thesis submitted for the degree of Doctor of Philosophy Flexibility in Real Estate Investment Markus M. Harder Clare Hall Summary Uncertainty about the future can have a considerable eect on current investment decisions. Investment in stages can help in spreading real estate development risk as it oers exibility for an otherwise inexible asset class. Here I present a continuous-time model that allows the valuation of a vertical phasing project with n stages as a perpetual compound option. I nd that the valuation of such a compound investment opportunity depends on parameters for all future stages, whereas the exercise policy per individual stage requires information solely on that stage; hence the optimal decision rule is independent of time, past stages, and future stages beyond the next. Previously, no analytical solution to the vertical phasing option existed and similar issues had only been analysed with innitesimally small steps and with no terminal stage. The solution presented in this research envelopes previous approaches and oers unique insights into exible design with a nite number of discrete investment stages. To give a broader perspective, I compare and contrast the vertical phasing option to other possible investment alternatives and illustrate cases for which the alternatives are most preferable. Because exibility comes at a cost, it must be carefully and separately evaluated for each potential investment opportunity. For a manager the presented threshold policy is straightforward and easy to implement. Through practitioner interviews I oer insights into the current status of real estate investment analysis. Lastly, I provide models that have practical relevance and employ a simulation approach to create a rened investment analysis model that can be used by real estate professionals. II Statements of Authenticity and Word Length Statement of Authenticity: I hereby declare that: ˆ this dissertation is the result of my own work and includes nothing which is the outcome of work done in collaboration except where specically indicated in the text ˆ my dissertation is not substantially the same as any that I have submitted for a degree or diploma or other qualication at any other University. I further state that no part of my dissertation has already been or is being concurrently submitted for any such degree, diploma or other qualication. Statement of Word Length: I hereby declare that: ˆ my dissertation does not exceed the limit of length prescribed in the Business and Management PhD regulations for which I am a candidate ˆ the length of my dissertation is 40,000 words. III Acknowledgements I want to thank Stefan Scholtes for being an excellent supervisor, coach and friend. You have given me guidance and feedback where needed and have let me run on my own where you felt something was to be discovered. I am honoured that Danny Ralph and Richard de Neufville have agreed to be my examiners. Furthermore, I am grateful to David Geltner, Rose Lai, Kirill Zavodov, Houyuan Jiang, Chander Velu, Aris Oraiopoulos, and Yun Shin Lee for giving constructive feedback on my research and for challenging my views along my journey. To the friends I made during my studies, especially Rutger-Jan Lange who has not only become a great friend but also my collaborator. To my lovely wife Wencke and my beautiful daughters Ruby and Rena. IV Extended Abstract Real estate is usually viewed as a xed and irreversible investment. Typically, real estate properties are built to last decades, have a certain usage type, and require a large, often sunk, initial investment cost. Real estate is the opposite of exible: it is rigid. Whereas built property is rigid, a decision on when and what to build on a plot of land can be taken exibly. Previous research treats land as an option to construct a property. This option represents exibility in the face of uncertainty since the owner of the land does not need to exercise the option to build until circumstances are favourable. Such a decision to construct and forgo such exibility should be taken not lightly but optimally. What if there were a way to exercise this option to build but at the same time maintain the exibility to alter specications or dimensions of a project later on? An investment in phases spreads the risks associated with large-scale irreversible investment and allows the decision maker to react more exibly to a wide range of possible future scenarios. In fact, it is possible to explore the import of exibility for real estate investment under uncertainty in a formal way. A framework of decision alternatives allows the categorising and comparing of dierent choices available to a real estate developer. The investment alternatives can then be modelled and evaluated explicitly. Within the framework, one of the alternatives is a staged investment oppor-tunity with a given number of expansion options. Staged investment can be viewed as an option on an option, or compound option. Until now, there has been no closed-form solution for a compound investment opportunity such as a 2- or n-stage investment. The main contribution of this research is an analytical solution to the sequential investment opportunity in the form of a perpetual compound option. One of the novel ndings for the perpetual compound option is that, whereas valuing such an opportunity depends on information on all future stages, the exercise policy per individual stage requires information solely on that stage. Hence, the derived threshold policy is straightforward and easy to implement. Exercising exibility while still maintaining additional options represents a exible alternative to classic real estate development. The individual alternatives of the proposed framework can be compared via a parametric analysis in order to identify regions of optimality where each alternative would be preferable to the others. In particular, the analysis V ... - tailieumienphi.vn