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Risk and uncertainty in development

Author

Listed:
  • Pavlos Loizou
  • Nick French

Abstract

Purpose - The purpose of this paper is to deal with the appropriateness of using the Monte Carlo simulation as a technique to calculate risk in real estate development. Design/methodology/approach - The paper is divided into two interlinked segments. The first segment examines the general definition of risk and Monte Carlo simulation methodology as a tool to estimate risk. The second outlines the appropriateness of using Monte Carlo as a tool to model real estate development, given the lack of data quality and its inability to account for human relationships in the development process. Findings - It is important that the Monte Carlo Simulation model is used as prescriptive model that builds on the original elicitation procedures; produces initial results; allows for detailed sensitivity analysis and then remodels as required. In short, to be fully effective, the Monte Carlo Simulation model needs to be used in a complementary fashion with an understanding of human judgement and decision making. Research limitations/implications - A fuller analysis may include an examination of the uncertainties in each of the components of the appraisal and account for the appropriate distributions of each of these variables. This is generally referred to as a Monte Carlo simulation. The argument in favour of a Monte Carlo simulation is that it helps the appraiser have a better understanding of the possible outcomes for the development and the relative impact of each input in the pricing of the project. Practical implications - A lot of work has been done looking at scenario modelling with probabilities and the results that ensue. However, it is important that these quantitative results are placed in the context of the heuristic and cognitive approaches adopted by the decision maker. In other words, the behaviour of the decision maker is as influential in the interpretation of the results as the numbers themselves. This paper looks at the advantages and disadvantages of using Monte Carlo simulation in this context. Originality/value - This study contributes significantly to the practical application of probability‐based models to development appraisal. The findings of the study are useful for users of feasibility studies to understand the context in which a development feasibility is carried out, and for appraisers to extend the scope of their analysis when carrying them out.

Suggested Citation

  • Pavlos Loizou & Nick French, 2012. "Risk and uncertainty in development," Journal of Property Investment & Finance, Emerald Group Publishing Limited, vol. 30(2), pages 198-210, March.
  • Handle: RePEc:eme:jpifpp:v:30:y:2012:i:2:p:198-210
    DOI: 10.1108/14635781211206922
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    Citations

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    Cited by:

    1. Christos L. Galanos, 2017. "Stress Testing the Effect of Income Tax Scale on a Full Time Agricultural Income in Greece After the New Tax Legislation," European Research Studies Journal, European Research Studies Journal, vol. 0(4A), pages 684-695.
    2. Christina Whidya Utami & Mochammad Ferdiansah, 2017. "Development of Knowledge Management Model in Establishing Innovation and Company Performance in UMKM/ SME1 in Indonesia," European Research Studies Journal, European Research Studies Journal, vol. 0(4B), pages 655-665.
    3. Claudius A. Peleskei & Vasile Dorca & Radu A. Munteanu & Radu Munteanu, 2015. "Risk Consideration and Cost Estimation in Construction Projects Using Monte Carlo Simulation," Management, University of Primorska, Faculty of Management Koper, vol. 10(2), pages 163-176.
    4. Obinna Collins Nnamani, 2018. "Application of Quantitative Risk Analysis in Property Development Projects in Nigeria: A Review," ERES eres2018_8, European Real Estate Society (ERES).
    5. Anastasios Tsamis & Konstantinos Liapis, 2014. "Property Assets Fair Value Accounting Under Uncertainty," European Research Studies Journal, European Research Studies Journal, vol. 0(4), pages 35-54.
    6. Chen, Yang & Zhang, Xiaoling & Chau, K.W. & Yang, Linchuan, 2022. "How the institutional change in urban redevelopment affects the duration of land redevelopment approval in China?," Land Use Policy, Elsevier, vol. 119(C).

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