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Real estate development as real options

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  • Eddie Chi-Man Hui
  • Hankel Hon-Kwok Fung

Abstract

One of the recent advances in property valuation is to view a property or the right to develop it as a call option. Shilling et al. (1985) were among the first to apply option pricing theory in this way. For real estate development, although not explicitly said so in his paper, Titman (1985) was the first to treat vacant lots of land as options to wait to develop. A frequently cited paper by Quigg (1993) presents the first empirical effort to support the real option pricing point of view. The valuation framework of Quigg (1993) is in one sense a specialization and in another sense a generalization of the framework of Williams (1991). Unfortunately, the works of both Williams and Quigg are technically flawed, but surprisingly their errors have gone unnoticed for over 15 years and are still propagating in the literature (e.g. in Yamaguchi et al., 2000 and Patel and Paxson, 2001). In the following, we will first address the flaws of Quigg (1993). Then we will examine the problems in Williams' (1991) work. Finally, we will discuss some implications of the Williams-Quigg valuation framework.

Suggested Citation

  • Eddie Chi-Man Hui & Hankel Hon-Kwok Fung, 2009. "Real estate development as real options," Construction Management and Economics, Taylor & Francis Journals, vol. 27(3), pages 221-227.
    • Handle: RePEc:taf:conmgt:v:27:y:2009:i:3:p:221-227
    DOI: 10.1080/01446190902759017
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    References listed on IDEAS

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    1. Quigg, Laura, 1993. "Empirical Testing of Real Option-Pricing Models," Journal of Finance, American Finance Association, vol. 48(2), pages 621-640, June.
    2. Schwartz, Eduardo S, 1997. "The Stochastic Behavior of Commodity Prices: Implications for Valuation and Hedging," Journal of Finance, American Finance Association, vol. 52(3), pages 923-973, July.
    3. Williams, Joseph T, 1991. "Real Estate Development as an Option," The Journal of Real Estate Finance and Economics, Springer, vol. 4(2), pages 191-208, June.
    4. Wilmott,Paul & Howison,Sam & Dewynne,Jeff, 1995. "The Mathematics of Financial Derivatives," Cambridge Books, Cambridge University Press, number 9780521497893, January.
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    Keywords

    Real estate; real options;

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