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Time to build options in construction processes

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  • Tien Foo Sing

Abstract

Time to build is a very important factor in a real estate development venture. Delay in completion of a project not only affects the financing costs and the rental revenue but also it may, on a more strategic note, determine the success or failure of a project. A time to build option model consisting of a stochastic rate of completion and a stochastic net project payoff is applied to the sequential construction process of a large scale construction project. The results of the sensitivity analysis show that the optimal payoff value, that triggers the exercise of the option to invest at a maximum rate, increases positively with the increases in cash flow volatility, input cost uncertainty, excess asset return per unit risk and maximum rate of investment. However, it has a negative relationship with the rental yield. In a case study involving a commercial project, the premium for hedging the payoff risks by pre-leasing a project was estimated at 11.29%, whereas the additional cost incurred for shielding a project against input cost risks in a design and build contract was estimated at 7.80%, where each is given as a percentage of the total construction costs.

Suggested Citation

  • Tien Foo Sing, 2002. "Time to build options in construction processes," Construction Management and Economics, Taylor & Francis Journals, vol. 20(2), pages 119-130.
    • Handle: RePEc:taf:conmgt:v:20:y:2002:i:2:p:119-130
    DOI: 10.1080/0144619011010209
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    Cited by:

    1. C. Y. Yiu & C. S. Tam, 2006. "Rational under-pricing in bidding strategy: a real options model," Construction Management and Economics, Taylor & Francis Journals, vol. 24(5), pages 475-484.

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