Economics of development strategies utilising option and portfolio analytics

Abstract

Purpose

The purpose of this paper is to integrate land use and option pricing theories using case study analyses to compare a portfolio of uses comprising single and mixed‐use development on the same site and assess the effects on the risk‐return profile of potential development schemes. The integration of land use development based on highest and best use (HBU) is tested against a combination of uses on the selected sites at a point in time in the downswing of the real estate cycle.

Design/methodology/approach

The proposed methodology integrates the development valuation approach with option theory in which both consider the relationships of cost and value associated with alternative development options. The approach used in this paper addresses the broader consideration of project coordination inclusive of land use flexibility and opportunity costs endogenously associated with development strategies. By investigating the uncertainty of economic options specific to the development process, the methodology considers the significance of complementary components of strategic decisions and entrepreneurial effort within a return/risk management strategy.

Findings

The stochastic model when compared to the real option model enhances strategic decisions and development project management by allowing the consideration of single/mixed‐use alternatives. The development process is facilitated by the research findings whereby alternative uses are tested to maximise the potential use of the site. The analyses consider optimal funding strategies in developing and investing for a range of use options on regeneration sites.

Practical implications

The significant insights apparent from the research is the quantification of the strategic specification of development as a productive process and an investment endeavour. The proposed model enables a comparison of a HBU based on a single development, a mixed‐use development or a combination of uses as the difference between the scenarios impacts on land value and profit measures, especially where these measures are calculated as distributive residuals.

Originality/value

The stochastic model developed in this paper provides a value‐added contribution to real estate literature by considering the complexity of the interrelationships between urban land economics, land use theory, valuation appraisal methodologies, portfolio analysis and option pricing as applied in the development of regeneration schemes.

Citation

Grissom, T.V., Berry, J.N. and Cheng J. Lim, L. (2010), "Economics of development strategies utilising option and portfolio analytics", Journal of European Real Estate Research, Vol. 3 No. 2, pp. 117-137. https://doi.org/10.1108/17539261011062600