REAL OPTIONS AND TIMING OF REAL ESTATE DEVELOPMENT

Abstract

Uncertainties can result when market conditions change between the time when the decision to build is made and the time the project is completed. These uncertainties are not taken into account when developers make decisions using the traditional Net Present Value rule. The growing significance of the real option theory has emphasized the value of options in answer to the uncertainties created. However, the application of the real option theory is known to be very much lacking in the real estate literature, and studies done in Singapore have been minimal. To add to the number of empirical researches done, this study is carried out to empirically test whether developers recognize the value of option to build and whether their strategies and decisions pertaining to the timing of their developments correspond with the past literature and research done on real options theory by using land transaction data in Singapore. This study is carried out with the use of duration analysis using a parametric model with Weibull distribution. The duration analysis allows us to analyze the option premium and various other macroeconomic and land related factors on their relationship with the timing of development. The empirical results show that there is a significantly positive relationship between the option premium and the timing of development and imply that the applications of the real option theory could be evident among the developers in Singapore.