Flexibility and Real Estate Valuation under Uncertainty

12Basic Flexibility in Development Projects: The Most Basic Flexibility in Real Estate Development is the Option to Choose whether and when to Build

LEARNING OBJECTIVES

• Review call (and put) options as defined by economists;
• Understand land as a call option on development;
• Appreciate call (and put) options as forms of flexibility;
• See implications regarding uncertainty and flexibility in project evaluation;
• Understand the value of flexibility to develop (or not).

OUTLINE OF THE CHAPTER

1. 12.1 Review of Call (and Put) Options
2. 12.2 Land as a Call Option on Development
3. 12.3 Drivers of Option Value
4. 12.4 A Practical Example of a Call (and Put) Option
5. 12.5 Flexibility and Scenario Analysis for Development Projects
6. 12.6 Conclusion

Flexibility is a way to manage and profit from uncertainty. It is the main theme and construct we introduce in this book. So far, we have discussed this in the context of existing built real estate properties. Beginning now and for the rest of the book, we view flexibility in the context of development projects. Indeed, these involve many different kinds of decisions concerning timing, scope, and composition. Development projects thus offer great opportunities for using flexibility to advantage, probably more so than investments in stabilized properties.

This chapter introduces flexibility in development by focusing on the simplest and most common type of flexibility, the decision of whether or not (in effect, the decision of when) to develop, ...