Flexibility and Real Estate Valuation under Uncertainty

14Product Options in Development: We Discuss Three types of Product Options

LEARNING OBJECTIVES

• Understand the concept of base plan;
• Introduce product expansion flexibility;
• Understand the difference between horizontal and vertical expansion flexibilities;
• Introduce product mix flexibility.

OUTLINE OF THE CHAPTER

1. 14.1 Concept of Base Plan
2. 14.2 Product Expansion Flexibility
3. 14.3 Product Mix Flexibility
4. 14.4 Conclusion

This chapter introduces you to three types of flexibilities concerning the scale or type of products (buildings) that development projects produce. These concern horizontal and vertical expansion, and flexibility in the mix of product.

14.1 Concept of Base Plan

In general, expansion options reflect the ability of the developer to add an additional quantity of built space to a “base plan” of the project. The base plan refers to the initial plan for the complete project, what the developer intends to build with a high degree of commitment. It is the reference point for our analyses.

For definitional clarity and analytical convenience, we focus on the notion of expansion options as being those that enable developers to add more total real estate product (greater amounts of built space), beyond that in the base plan.

Developers may, of course, exercise flexibility to abandon parts of the base plan. This possibility, a type of defensive option, is inherently part of the way we define the production timing options to be described in Chapter 15.