Timing decisions of housing sales and development based on real option theory
Abstract
Based on the real option theory, this paper studies the impact of uncertainty on the timing decisions required in housing development and sales. Data of newly-built houses and corresponding plots in Hangzhou, China, are used for empirical analysis. In order to better reflect the changes in market demand under frequent policy intervention, in addition to the usual price volatility, this paper introduces the volatility of trading volume to measure the uncertainty of China’s real estate market. The results show that the volatility of trading volume has a significant impact on timing decisions. Also, trading volume volatility can better reflect the characteristic of deferred option than can price volatility, especially during the sales phase. This study provides evidence to support Bar-Ilan and Strange’s (1998) research of sequential investment. Because of the existence of the second option, i.e., sales timing, the starts in the first stage are not too sensitive to uncertainty. In the case of the second option, the longer the construction period is, and the lower the cost of the first stage is, the higher will be the probability of triggering the start. In addition, the characteristics of market risk aversion are obvious in the study area, especially in the suburban area.
First published online 29 December 2020
Keyword : real option, survival analysis, timing of land development, timing of house sales, uncertainty, trading volume
How to Cite
Zhang, L., Shi, D., Chang, X., & Wen, H. (2021). Timing decisions of housing sales and development based on real option theory. International Journal of Strategic Property Management, 25(2), 90-101. https://doi.org/10.3846/ijspm.2020.13973
This work is licensed under a Creative Commons Attribution 4.0 International License.
References
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Bulan, L., Mayer, C., & Somerville, C. T. (2009). Irreversible investment, real options, and competition: evidence from real estate development. Journal of Urban Economics, 65(3), 237– 251. https://doi.org/10.1016/j.jue.2008.03.003
Capozza, D. R., & Helsley, R. W. (1990). The stochastic city. Journal of Urban Economics, 28(2), 187–203. https://doi.org/10.1016/0094-1190(90)90050-W
Capozza, D., & Li, Y. (1994). The intensity and timing of investment: the case of land. The American Economic Review, 84(4), 889–904. https://www.jstor.org/stable/2118036
Capozza, D. R., & Li, Y. (2001). Residential investment and interest rates: an empirical test of land development as a real option. Real Estate Economics, 29(3), 503–519.
https://doi.org/10.1111/1080-8620.00020
Childs, P. D., Ott, S. H., & Triantis, A. J. (1998). Capital budgeting for interrelated projects: a real options approach. The Journal of Financial and Quantitative Analysis, 33(3), 305–334. https://doi.org/10.2307/2331098
Childs, P. D., Ott, S. H., & Riddiough, T. J. (2001). Valuation and information acquisition policy for claims written on noisy real assets. Financial Management, 30(2), 45–75. https://doi.org/10.2307/3666405
Clarke, H. R., & Reed, W. J. (1988). A stochastic analysis of land development timing and property valuation. Regional Science and Urban Economics, 18(3), 357–381. https://doi.org/10.1016/0166-0462(88)90014-2
Cox, D. R. (1972). Regression models and life-tables. Journal of the Royal Statistical Society, 34(2), 187–220. https://doi.org/10.1111/j.2517-6161.1972.tb00899.x
Cunningham, C. R. (2006). House price uncertainty, timing of development, and vacant land prices: evidence for real options in Seattle. Journal of Urban Economics, 9(1), 1–31. https://doi.org/10.1016/j.jue.2005.08.003
Dixit, A. K., & Pindyck, R. S. (1994). Investment under uncertainty. Princeton University Press. https://doi.org/10.2307/j.ctt7sncv
Dong, Z., & Sing, T. F. (2017). Developers’ heterogeneity and real estate development timing options. Journal of Property Investment & Finance, 35(5), 472–488. https://doi.org/10.1108/JPIF-07-2016-0058
Friedl, G. (2002). Sequential investment and time to build. Schmalenbach Business Review, 54(1), 58–79. https://doi.org/10.1007/BF03396645
Galster, G. (2001). On the nature of neighbourhood. Urban Studies, 38, 2111–2124. https://doi.org/10.1080/00420980120087072
Grenadier, S. R. (1999). Information revelation through option exercise. Review of Financial Studies, 12(1), 95–129. https://doi.org/10.1093/rfs/12.1.95
Grovenstein, R. A., Kau, J. B., & Munneke, H. J. (2011). Development value: a real options approach using empirical data. The Journal of Real Estate Finance and Economics, 43(3), 321–335. https://doi.org/10.1007/s11146-010-9277-9
Guthrie, G. (2010). House prices, development costs, and the value of waiting. Journal of Urban Economics, 68(1), 56–71. https://doi.org/10.1016/j.jue.2010.02.002
Jou, J. B., & Lee, T. C. (2015). How do density ceiling controls affect housing prices and urban boundaries? The Journal of Real Estate Finance and Economics, 50(2), 219–241. https://doi.org/10.1007/s11146-014-9460-5
Kort, P. M., Murto, P., & Pawlina, G. (2010). Uncertainty and stepwise investment. European Journal of Operational Research, 202(1), 196–203. https://doi.org/10.1016/j.ejor.2009.05.027
Lee, T., & Jou, J. B. (2010). Urban spatial development: a real options approach. The Journal of Real Estate Finance and Economics, 40(2), 161–187. https://doi.org/10.1007/s11146-008-9135-1
Martins, G. B., & da Silva, M. E. (2005). A real option model with uncertain, sequential investment and with time to build. Revista Brasileira de Finanças, 3(2), 141–172. https://doi.org/10.12660/rbfin.v3n2.2005.1148
Mayor, N., Schonbucher, P., Wilmott, P., Whalley, A. E., & Epstein, D. (1999). The value of market research when a firm is learning: real option pricing and optimal filtering (OFRC Working Papers). Oxford Financial Research Centre.
Mcdonald, R., & Siegel, D. (1986). The value of waiting to invest. The Quarterly Journal of Economics, 101(4), 707–727. https://doi.org/10.2307/1884175
Miles, W. (2009). Irreversibility, uncertainty and housing investment. The Journal of Real Estate Finance and Economics, 38(2), 173–182. https://doi.org/10.1007/s11146-007-9087-x
Ong, S. E., & Cheng, F. J. (1996). Optimal signals for real estate and construction firms operating under information asymmetry. Journal of Real Estate and Construction, 6(1), 17–31.
Ott, S. H., Hughen, W. K., & Read, D. C. (2012). Optimal phasing and inventory decisions for large-scale residential development projects. The Journal of Real Estate Finance and Economics, 45(4), 888–918. https://doi.org/10.1007/s11146-011-9299-y
Quigg, L. (1993). Empirical testing of real option‐pricing models. The Journal of Finance, 48(2), 621–640. https://doi.org/10.1111/j.1540-6261.1993.tb04730.x
Rocha, K., Salles, L., Garcia, F. A. A., Sardinha, J. A., & Teixeira, J. P. (2007). Real estate and real options – a case study. Emerging Markets Review, 8(1), 67–79. https://doi.org/10.1016/j.ememar.2006.09.008
Shen, J., & Pretorius, F. (2013). Binomial option pricing models for real estate development. Journal of Property Investment and Finance, 31(5), 418–440. https://doi.org/10.1108/JPIF-10-2012-0046
Somerville, C. T. (2001). Permits, starts, and completions: structural relationships versus real options. Real Estate Economics, 29(1), 162. https://doi.org/10.1111/1080-8620.00006
Titman, S. (1985). Urban land prices under uncertainty. The American Economic Review, 75(3), 505–514. https://www.jstor.org/stable/1814815
Wang, Y. (2012). Timing decision of land supply, project development and phased sales: based on real option. Zhejiang University.
Wang, Y., Tang, W., & Jia, S. (2016). Uncertainty, competition and timing of land development: theory and empirical evidence from Hang Zhou, China. Journal of Real Estate Finance and Economics, 53(2), 218–245. https://doi.org/10.1007/s11146-015-9517-0
Williams, J. T. (1991). Real estate development as an option. The Journal of Real Estate Finance and Economics, 4(2), 191–208. https://doi.org/10.1007/BF00173124
Yang, Z., Zhang, X., & Zhang, Y. (2015). Effect of housing price uncertainty on trading behavior of developers. Journal of Engineering Management, 29(2), 126–131.
Zhou, X., Qin, Z., Zhao, S., & Chai, D. (2019). The spatial pattern, evolution characteristics and influencing factors of land share in housing price in China: a spatial econometric analysis of 35 large and medium-size cities. China Land Science, 33(1), 40–48.
Berkovec, J. A., & Goodman, J. L. (1996). Turnover as a measure of demand for existing homes. Real Estate Economics, 24(4), 421–440. https://doi.org/10.1111/1540-6229.00698
Bulan, L., Mayer, C., & Somerville, C. T. (2009). Irreversible investment, real options, and competition: evidence from real estate development. Journal of Urban Economics, 65(3), 237– 251. https://doi.org/10.1016/j.jue.2008.03.003
Capozza, D. R., & Helsley, R. W. (1990). The stochastic city. Journal of Urban Economics, 28(2), 187–203. https://doi.org/10.1016/0094-1190(90)90050-W
Capozza, D., & Li, Y. (1994). The intensity and timing of investment: the case of land. The American Economic Review, 84(4), 889–904. https://www.jstor.org/stable/2118036
Capozza, D. R., & Li, Y. (2001). Residential investment and interest rates: an empirical test of land development as a real option. Real Estate Economics, 29(3), 503–519.
https://doi.org/10.1111/1080-8620.00020
Childs, P. D., Ott, S. H., & Triantis, A. J. (1998). Capital budgeting for interrelated projects: a real options approach. The Journal of Financial and Quantitative Analysis, 33(3), 305–334. https://doi.org/10.2307/2331098
Childs, P. D., Ott, S. H., & Riddiough, T. J. (2001). Valuation and information acquisition policy for claims written on noisy real assets. Financial Management, 30(2), 45–75. https://doi.org/10.2307/3666405
Clarke, H. R., & Reed, W. J. (1988). A stochastic analysis of land development timing and property valuation. Regional Science and Urban Economics, 18(3), 357–381. https://doi.org/10.1016/0166-0462(88)90014-2
Cox, D. R. (1972). Regression models and life-tables. Journal of the Royal Statistical Society, 34(2), 187–220. https://doi.org/10.1111/j.2517-6161.1972.tb00899.x
Cunningham, C. R. (2006). House price uncertainty, timing of development, and vacant land prices: evidence for real options in Seattle. Journal of Urban Economics, 9(1), 1–31. https://doi.org/10.1016/j.jue.2005.08.003
Dixit, A. K., & Pindyck, R. S. (1994). Investment under uncertainty. Princeton University Press. https://doi.org/10.2307/j.ctt7sncv
Dong, Z., & Sing, T. F. (2017). Developers’ heterogeneity and real estate development timing options. Journal of Property Investment & Finance, 35(5), 472–488. https://doi.org/10.1108/JPIF-07-2016-0058
Friedl, G. (2002). Sequential investment and time to build. Schmalenbach Business Review, 54(1), 58–79. https://doi.org/10.1007/BF03396645
Galster, G. (2001). On the nature of neighbourhood. Urban Studies, 38, 2111–2124. https://doi.org/10.1080/00420980120087072
Grenadier, S. R. (1999). Information revelation through option exercise. Review of Financial Studies, 12(1), 95–129. https://doi.org/10.1093/rfs/12.1.95
Grovenstein, R. A., Kau, J. B., & Munneke, H. J. (2011). Development value: a real options approach using empirical data. The Journal of Real Estate Finance and Economics, 43(3), 321–335. https://doi.org/10.1007/s11146-010-9277-9
Guthrie, G. (2010). House prices, development costs, and the value of waiting. Journal of Urban Economics, 68(1), 56–71. https://doi.org/10.1016/j.jue.2010.02.002
Jou, J. B., & Lee, T. C. (2015). How do density ceiling controls affect housing prices and urban boundaries? The Journal of Real Estate Finance and Economics, 50(2), 219–241. https://doi.org/10.1007/s11146-014-9460-5
Kort, P. M., Murto, P., & Pawlina, G. (2010). Uncertainty and stepwise investment. European Journal of Operational Research, 202(1), 196–203. https://doi.org/10.1016/j.ejor.2009.05.027
Lee, T., & Jou, J. B. (2010). Urban spatial development: a real options approach. The Journal of Real Estate Finance and Economics, 40(2), 161–187. https://doi.org/10.1007/s11146-008-9135-1
Martins, G. B., & da Silva, M. E. (2005). A real option model with uncertain, sequential investment and with time to build. Revista Brasileira de Finanças, 3(2), 141–172. https://doi.org/10.12660/rbfin.v3n2.2005.1148
Mayor, N., Schonbucher, P., Wilmott, P., Whalley, A. E., & Epstein, D. (1999). The value of market research when a firm is learning: real option pricing and optimal filtering (OFRC Working Papers). Oxford Financial Research Centre.
Mcdonald, R., & Siegel, D. (1986). The value of waiting to invest. The Quarterly Journal of Economics, 101(4), 707–727. https://doi.org/10.2307/1884175
Miles, W. (2009). Irreversibility, uncertainty and housing investment. The Journal of Real Estate Finance and Economics, 38(2), 173–182. https://doi.org/10.1007/s11146-007-9087-x
Ong, S. E., & Cheng, F. J. (1996). Optimal signals for real estate and construction firms operating under information asymmetry. Journal of Real Estate and Construction, 6(1), 17–31.
Ott, S. H., Hughen, W. K., & Read, D. C. (2012). Optimal phasing and inventory decisions for large-scale residential development projects. The Journal of Real Estate Finance and Economics, 45(4), 888–918. https://doi.org/10.1007/s11146-011-9299-y
Quigg, L. (1993). Empirical testing of real option‐pricing models. The Journal of Finance, 48(2), 621–640. https://doi.org/10.1111/j.1540-6261.1993.tb04730.x
Rocha, K., Salles, L., Garcia, F. A. A., Sardinha, J. A., & Teixeira, J. P. (2007). Real estate and real options – a case study. Emerging Markets Review, 8(1), 67–79. https://doi.org/10.1016/j.ememar.2006.09.008
Shen, J., & Pretorius, F. (2013). Binomial option pricing models for real estate development. Journal of Property Investment and Finance, 31(5), 418–440. https://doi.org/10.1108/JPIF-10-2012-0046
Somerville, C. T. (2001). Permits, starts, and completions: structural relationships versus real options. Real Estate Economics, 29(1), 162. https://doi.org/10.1111/1080-8620.00006
Titman, S. (1985). Urban land prices under uncertainty. The American Economic Review, 75(3), 505–514. https://www.jstor.org/stable/1814815
Wang, Y. (2012). Timing decision of land supply, project development and phased sales: based on real option. Zhejiang University.
Wang, Y., Tang, W., & Jia, S. (2016). Uncertainty, competition and timing of land development: theory and empirical evidence from Hang Zhou, China. Journal of Real Estate Finance and Economics, 53(2), 218–245. https://doi.org/10.1007/s11146-015-9517-0
Williams, J. T. (1991). Real estate development as an option. The Journal of Real Estate Finance and Economics, 4(2), 191–208. https://doi.org/10.1007/BF00173124
Yang, Z., Zhang, X., & Zhang, Y. (2015). Effect of housing price uncertainty on trading behavior of developers. Journal of Engineering Management, 29(2), 126–131.
Zhou, X., Qin, Z., Zhao, S., & Chai, D. (2019). The spatial pattern, evolution characteristics and influencing factors of land share in housing price in China: a spatial econometric analysis of 35 large and medium-size cities. China Land Science, 33(1), 40–48.