A Real Options Model of Real Estate Development with Entitlement Risk. (26th May 2019)

• Record Type: Journal Article
• Authors: Cheng, Yiying; Clark, Steven P.; Womack, Kiplan S.
• Is Part Of: Real estate economics. Volume 49:Number 1(2021)
• Page Start: 106
• Page End: 151
• Publication Date: 2019-05-26
• Subjects: Real estate business -- United States -- Periodicals; Urban economics -- Periodicals; 333.33097
• DOI: 10.1111/1540-6229.12282
• Languages: English
• ISSNs: 1080-8620

Abstract

Abstract: Most development projects encounter a highly uncertain entitlement process that is largely uncontrollable by developers. In this study, entitlement is modeled as a separate stage within a compound real option, where developers begin with minimal control (maximum risk) and each successful stage increases control (decreases risk). We solve the model analytically, provide three‐dimensional numerical comparisons, and empirically test the model's predictions using hand collected rezoning petitions. Our main result refines the classic development option model: developers first invest early (secure entitlements) in order to obtain the option to subsequently delay investment (construct the optimal building at the optimal time).