Flexibility and Real Estate Valuation under Uncertainty

11Development Project Valuation: This Chapter Looks at Valuation of Development Projects From an Investment Perspective, Considering Uncertainty, Flexibility, and Time‐to‐Build

LEARNING OBJECTIVES

• Understand the differences between investment in existing assets and investment in development projects: development projects also involve “time‐to‐build” and construction costs;
• Appreciate why opportunity cost of capital (OCC) for construction costs is lower than for investment in existing assets;
• See how these differences change the net present value (NPV) valuation framework for investment in development projects;
• Understand the fair valuation of land for a development project;
• Appreciate how development projects can be more profitable, but also riskier, than investments in otherwise similar existing assets.

OUTLINE OF THE CHAPTER

1. 11.1 Time‐to‐Build Difference between Development Projects and Existing Assets
2. 11.2 Lower Opportunity Cost of Capital for Construction Costs
3. 11.3 Illustrative Example
4. 11.4 Residual Value of Development Land
5. 11.5 Investment Risk in Development Project
6. 11.6 Conclusion

Until now, we’ve focused our analysis on an existing productive asset—archetypically, a rental property. Such assets represent the bulk of real estate investment in many countries, and they are, in some sense, the primal or underlying asset of real estate. They provide productive services for long periods, evidenced by the rental income flow that they do, or could, generate. ...