Demand Uncertainty, Development Timing and Leasehold Land Valuation: Empirical Testing of Real Options in Residential Real Estate Development

This article develops and tests a long‐dated American call option pricing model for valuing development land under leasehold. We analyze and test option values in ten detailed Hong Kong cases involving purchase, holding, converting and developing land. We also test for optimal exercise of long‐dated...

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Bibliographic Details
Published in:Real estate economics 2014-12, Vol.42 (4), p.829-868
Main Authors: Yao, Huimin, Pretorius, Frederik
Format: Article
Language:English
Subjects:
Leasehold
Mathematical models
Property values
Put & call options
Real estate developments
Securities prices
Studies
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Summary:This article develops and tests a long‐dated American call option pricing model for valuing development land under leasehold. We analyze and test option values in ten detailed Hong Kong cases involving purchase, holding, converting and developing land. We also test for optimal exercise of long‐dated American calls using processes based on the optimal trigger ratio feature of the perpetual American call option model. Generally, the empirical results confirm presence of a positive and nontrivial option premium (mean +5.274%) in the cases, and that developers appear to delay exercise to the point predicted by the real options model.
ISSN:1080-8620
1540-6229
DOI:10.1111/1540-6229.12052