Land Development: Risk, Return and Risk Management

2007

This thesis introduces a streamlined model that incorporates the value of the real options that exist in real estate development projects. 1 Real options add value to a project by providing developers with flexibility to minimize downside risk or take advantage of upside potential as conditions change from deterministic expectations. Though developers currently incorporate this value into their decision making using intuition and judgment, the model presented here provides a tool with which developers can value options in a rigorous and quantitative fashion. Though the model should not be used as a comprehensive land residual model, it serves as a powerful proof of concept for real options analysis in the field of real estate. Further, it can be used to measure the relative value and risk of projects with and without real options.

Property-related assets, along with sovereign debt, are the main burden for the balances of the Spanish Banking sector. This paper proposes a real-option approach to properly value the risk associated to loans to the property promoters. Banks could protect the loans to housing development projects by charging a premium based on the value of the real option associated to the project.

2011

We study the developable land market in French periurban and rural areas under urban influence. Theoretical aspects and empirical results are derived from urban economics to analyse the main determinants of the price of developable land: distance from the urban centres, population, inhabitantsí income, etc. We focus especially on option values that come from irreversibility of development of farmland into residential plots, with uncertainly and inflow of information from the market. The classical option value, due to temporal price volatility (ìprice riskî), is introduced into an econometric model. The novel contribution of the paper is to introduce also uncertainly regarding the spatial volatility of the demographic evolution in a spatial buffer around each transaction (ìpopulation riskî), which generates a second option value. We use three individual data sets that describe the market of developable land: a very complete database available for the North department3 (31551 obs...

The Journal of Real Estate Finance and Economics, 2005

This paper examines the distortions in property markets resulting from government actions to alleviate externalities associated with vacant lots. Using an equilibrium based real option model, the analysis indicates that announcement of a program of forced development may actually delay market-based development. By incorporating externalities associated with vacant lots into the model, the analysis indicates that owners of neighboring developed property benefit suggesting such programs will be politically popular.

2005

Journal of Finance, 1996

This article develops an equilibrium framework for strategic option exercise games. I focus on a particular example: the timing of real estate development. An analysis of the equilibrium exercise policies of developers provides insights into the forces that shape market behavior. The model isolates the factors that make some markets prone to bursts of concentrated development. The model also provides an explanation for why some markets may experience building booms in the face of declining demand and property values. While such behavior is often regarded as irrational overbuilding, the model provides a rational foundation for such exercise patterns.

Journal of Real Estate Research, 1997

This paper tests various hypotheses related to expectations and the value of undeveloped land. Evidence is found to support the hypothesis by Capozza and Helsley (1989) that the price of land in rapidly growing cities reflects a significant premium based upon expectations about future growth. There is also evidence that this premium varies from less than 40% of land value during down times to over 70% during boom times. Additional hypotheses tested related to development expectations for smaller geographic areas within the market. Land values reflect forecasts of employment up to five or six years into the future for nine square mile planning areas. The level of residential development activity from two to three miles around individual parcels is also capitalized into value. Much of the value of urban land may be explained by the growth rate of the metropolitan area and micro-geographic factors related to individual parcels.

Proceedings of the 20th Annual European Real Estate Society Conference - Vienna, Austria, 2013

The recovery of brownfield sites has been in the past, and still is today, at the centre of urban policies which have established and, in some cases, completed key urban transformation projects. In this regard, it should be noted that a preliminary remediation is often required for large transformation areas before urban functions can be established. Among other things, the recovery of these areas represents a matter of public interest in connection with environmental protection and public health goals. Investment decisions in relation to the development of brownfields are affected, primarily, by two critical variables: the remediation costs and market value of the area after the environmental recovery has been completed. This is in fact a complex process, which cannot be estimated with certainty, and which is influenced by a large number of variables. These include, for example, the characteristics of the project, the timing, the technology and the level of uncertainty in achieving the urban revitalization goals. In the past and in many countries, the use of public resources was the preferred means of encouraging the development of urban transformation projects of contaminated lands. On the contrary, the current economic scenario requires a new insight. One possibility would be to involve private developers from the early stages of the transformation. In this regard, given the uncertainty surrounding the remediation costs, some studies have aimed to define the financial and economic feasibility of the recovery of brownfields through the Real Options Theory (ROT). In this light, this study attempts to argue and support the application of the ROT. It focuses on a contaminated area intended for transformation from an industrial to a residential and commercial use, but for which remediation costs are unavoidable, although their impact is low. By changing the future scenarios, the application of the Black & Scholes formula compares and makes evident the points of view of the landowner, the real estate developer, and the public sector.

Empirical Economics, 2008

The Modigliani-Miller (M-M) theorem of financial asset theory concludes that asset values are independent of financing. In other words, debtsolvency (credit constraints) does not affect asset values. Therefore, using the M-M theorem one can argue that credit constraints in the farm sector (where land is the most important asset) do not affect the value of farmland. However, this proof relies on several arbitrage assumptions that are violated in the case of agricultural assets. This paper examines the effect of debt-solvency and government payments on changes in annual farmland values by state in the United States. Using panel cointergration method, results indicate that farmland values are significantly affected by both solvency and government payments. In addition, the results imply that government payments may affect agricultural asset values beyond the direct effect hypothesized in the literature.

Our study examines the role of restrictions on the new land supply in changing the sources of risk of investing in Hong Kong property companies (indirect real estate). In particular, we investigate whether development oriented property company had higher idiosyncratic (unexplained) risk during the period when supply of new land through auction by the government was restricted (1984)(1985)(1986)(1987)(1988)(1989)(1990)(1991)(1992)(1993)(1994)(1995)(1996)(1997). We utilized quarterly data from 2Q1978 to 4Q2005 to estimate the multifactor variance decomposition models. Our empirical results show that there was a significant increase in idiosyncratic risk for the all listed property companies from 1984 to 1997. This supports the prediction of our hypothesis that restrictions on the supply of new developable land will result in an increase in the indirect real estate idiosyncratic risk, the major source of which is the uncertainty in obtaining approvals before development, which does not exist for newly supplied land. We also found that development oriented property companies, as opposed to investment oriented property companies, experienced a larger increase in idiosyncratic risk from 1984 to 1997. These findings are also applicable to any changes in policy/legislation, physical constraints, or other factors that resulted in a decline in the ratio of new developable land (free of pre-development risk) to all sources of land for development.