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Article
Publication date: 29 April 2020

Niina Leskinen, Jussi Vimpari and Seppo Junnila

Contrary to the traditional technology project perspective, real estate investors see building-specific renewable energy (on-site energy) investments as part of the…

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Abstract

Purpose

Contrary to the traditional technology project perspective, real estate investors see building-specific renewable energy (on-site energy) investments as part of the property and as something affecting the property’s ability to produce a (net) cash flow. This paper aims to show the value-influencing mechanism of on-site energy production from a professional property investors’ perspective.

Design/methodology/approach

The value-influencing mechanism is presented with a case study of a prime logistics property located in the Helsinki metropolitan area, Finland. The case study results are compared with the results of a survey answered by over 70 property valuation professionals in the Finnish real estate market.

Findings

Current valuation practice supports the presented value-creation mechanism based on the capitalisation of the savings generated by a building’s own energy production. Valuation professionals see benefits beyond decreased operating expenses such as enhanced image and better saleability. However, valuers acted more conservatively than expected when transferring these additional benefits to the cash flows of the case property.

Practical implications

Because the savings in operating expenses can be capitalised into the property value, property investors should consider on-site energy production when the return of on-site energy exceeds the return of the property. This enhances the profitability of on-site energy, especially in urban areas with low initial yields.

Originality/value

This is the first research paper to open the value-influencing mechanism of on-site energy production from a professional property investors’ perspective in commercial properties and to confirm it from a market study.

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Article
Publication date: 13 September 2018

Jussi Vimpari

The purpose of this paper is to analyse the problem that arises when a tenant’s space needs will likely change in the future, but the property owner would prefer to…

Abstract

Purpose

The purpose of this paper is to analyse the problem that arises when a tenant’s space needs will likely change in the future, but the property owner would prefer to continue renting the initial space to the same tenant. The study builds upon ideas on structuring option values into initial rent and proposes a method for evaluating the value of adaptability for both the tenants and the owners.

Design/methodology/approach

The methodology is based on real option pricing, and it includes key variables of building adaptability, lease agreement terms and property market information. The methodology explains the importance of understanding the concept of volatility related to space needs and how it affects the tenant’s decision to either remain or vacate the rented premises. Real option pricing theory highlights the problem of using linearly growing expectations for physical assets and the obvious problems that arise with that assumption.

Findings

This paper suggests that the principles of option pricing could be used in valuing building adaptability to find the optimal initial rent from both the owner’s and the tenant’s perspective. It is pointed that the volatility of the tenant’s future space requirements should drive the effective rent paid by the tenant. The paper argues as to why the owner is better off if the tenant can downscale (with building adaptability) their current space rather than vacate the whole space. Additionally, this paper presents the reasons for why the tenant should pay more for a space that has such a downscaling option. Eventually, both the owner and the tenant are better off because, from the tenant’s perspective, unnecessary relocating costs can be avoided, and from the owner’s perspective, unnecessary re-renting costs can be avoided.

Practical implications

The paper demonstrates how the downscaling option creates value for both the owner and the tenant. The owner benefits from higher average occupancy rates, and during lease break points, only part of the premises has to be re-rented rather than the entire premises. When these higher occupancy rates are transferred into cash flows with relevant market parameters, it is evident how the rates create extra value for the property owner and for the tenant, subject to lease terms.

Originality/value

The owner benefits from the higher rent, even though there might be more lease break points where parts of the building must be rented out. If these kinds of option values can be communicated transparently, it should be possible for the owner and the tenant to agree on such terms.

Details

Journal of European Real Estate Research, vol. 11 no. 3
Type: Research Article
ISSN: 1753-9269

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Article
Publication date: 3 July 2017

Jussi Vimpari and Seppo Junnila

Retail properties are a perfect example of a property class where revenues determine the rent for the property owners. Estimating the value of new retail developments is…

Abstract

Purpose

Retail properties are a perfect example of a property class where revenues determine the rent for the property owners. Estimating the value of new retail developments is challenging, as the initial revenues can have a significant variance from the long-term revenue levels. Owners and tenants try to manage this problem by introducing different kind of options, such as overage rent and extension rights, to the lease contracts. The purpose of this paper is to value these options through time for different types of retailers, using real-life data with a method that can be easily applied in practice.

Design/methodology/approach

This paper builds upon the existing papers on real option studies but has a strong practical focus, which has been identified as a challenge in the field. The paper presents simple mathematical equations for valuing overage rent and extension options. The equations capture the value related to uncertainty (volatility) that is missed by standard valuation practices.

Findings

The results indicate that overage and extension options can represent a significant proportion of retail lease contract’s value and their value is heavily time-dependent. The option values differ greatly between tenants, as the volatilities can have a large spread across tenants. The paper suggests that the applicability of option pricing theory and calculus should not be considered as an insurmountable barrier any more, rather a greater challenge for the practical adaptability of the method can be the availability of real-life data that is a common problem in real option analysis.

Practical implications

The value of extension and overage options varies greatly between tenants. In general, the property owner can try balance the positive effects from the overage rents to the negative effects of tenant extensions. However, this study tries to highlight that, as usual, using the “law of averages” can result into poor valuation in this context as well. Even the data used in this study provide valuable findings for the property owner as an analytical deduction can be made that certain types of tenants have higher volatilities and this should be acknowledged when valuing options within lease contracts.

Originality/value

Previous literature in this topic often takes the input data for the option valuation as granted rather than trying to identify the real-life data available for the calculation. This is a common problem in real options valuation and it seems to be one of the reasons why option valuation has not been used widely in practice. This study has used real-life data to assess the problem and more importantly assessed the data across different types of tenants. The volatility spread between different types of tenants has not been discussed previously, even though it has a significant importance when using option pricing in practice.

Details

Journal of Property Investment & Finance, vol. 35 no. 4
Type: Research Article
ISSN: 1463-578X

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Article
Publication date: 29 July 2014

Jussi Vimpari and Seppo Junnila

The purpose of this study is first to evaluate whether real options analysis (ROA) is suitable for valuing green building certificates, and second to calculate the real…

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1520

Abstract

Purpose

The purpose of this study is first to evaluate whether real options analysis (ROA) is suitable for valuing green building certificates, and second to calculate the real option value of a green certificate in a typical office building setting. Green buildings are demonstrated as one of the most profitable climate mitigation actions. However, no consensus exists among industry professionals about how green buildings and specifically green building certificates should be valued.

Design/methodology/approach

The research design of the study involves a theoretical part and an empirical part. In the theoretical part, option characteristics of green building certificates are identified and a contemporary real option valuation method is proposed for application. In the empirical part, the application is demonstrated in an embedded multiple case study design. Two different building cases (with and without green certificate) with eight independent cash flow valuations by eight industry professionals are used as data set for eight valuation case studies and analyses. Additionally, cross-case analysis is executed for strengthening the analysis.

Findings

The paper finds that green certificates have several characteristics similar to real options and supports the idea of using ROA in valuing a green certificate. The paper also explains how option pricing theory and discounted cash flow (DCF) method deal with uncertainty and what shortcomings of DCF could be overcome by ROA. The results show that a mean real option value of 985,000 (or 8.8 per cent premium to the mean property value) was found for a Leadership in Energy and Environmental Design Platinum certificate in the Finnish property market. The main finding of the paper suggests that the contemporary real option valuation methods are appropriate to assess the monetary value and the uncertainty of a green building certificate.

Originality/value

This is the first study to argue that option-pricing theory can be used for valuing green building certificates. The identification of the option characteristics of green building certificates and demonstration of the ROA in an empirical case makes questions whether the current mainstream investment analysis approaches are the most suitable methods for valuing green building certificates.

Details

Journal of European Real Estate Research, vol. 7 no. 2
Type: Research Article
ISSN: 1753-9269

Keywords

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Article
Publication date: 1 April 2014

Jussi Vimpari, Juho-Kusti Kajander and Seppo Junnila

The need for flexibility between organisational units is well established in corporate real estate. While the cost of flexibility is rather straightforward to approximate…

Abstract

Purpose

The need for flexibility between organisational units is well established in corporate real estate. While the cost of flexibility is rather straightforward to approximate, measuring economical value of the flexibility is not straightforward. The purpose of this paper is to explore how real options analysis can be used for valuing flexibility in a real retrofit investment case, present a research process for valuing the flexibility in the retrofit investment case, and evaluate the empirical usability of real options valuation results compared with traditional discounted cash flow valuation results.

Design/methodology/approach

The research is conducted as a case study. A newly introduced real options valuation method, the fuzzy pay-off method is used for analysing data from a Finnish office building retrofit investment case. The major difference in the selected method is that it uses fuzzy set theory instead of probabilistic theory, and the main advantage is the practical applicability, i.e. only three scenarios (minimum, best guess, and maximum) are needed for the valuation of flexibility. In the case, the scenarios are determined using a seven-phase research process that incorporates data available (e.g. rental agreements, building information) to a corporate real estate unit. The research process involves defining vacancy scenarios for rental agreements, transforming them into potential income achievable with flexibility, estimating cost of flexibility, comparing the potential income with the costs, and valuing the real options.

Findings

The main finding of this paper is that real options analysis; especially the fuzzy pay-off method can be used for assessing the monetary value of flexibility. The applicability of the fuzzy pay-off method into a practical investment case was found straightforward because assignment of probabilities into different uncertainty scenarios was unnecessary. In the empirical case, it was found that flexibility investments were profitable only when parts of the building instead of the whole building were designed flexible. The present value of the pay-off from flexibility ranged from negative 58/sqm to positive 130/sqm, depending on the tenant.

Originality/value

Real options literature, especially in the real estate and construction sector, has requested for new applications of real options analysis in practical setting. This paper adds to that request with an example of evaluating flexibility in a retrofit investment case. The empirical analysis produced in this paper was perceived valuable by case study investor and can be used as a guidance and motivation for further applications of real options in the industry.

Details

Journal of Corporate Real Estate, vol. 16 no. 1
Type: Research Article
ISSN: 1463-001X

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Article
Publication date: 14 October 2014

Jussi Vimpari and Seppo Junnila

The value of waiting to invest has been acknowledged in management of real capital investments. Investment decision should be undertaken only if it can justify giving up…

Abstract

Purpose

The value of waiting to invest has been acknowledged in management of real capital investments. Investment decision should be undertaken only if it can justify giving up the value of the option to wait; the same logic is proposed here to be applicable on divestment management of a real estate fund. The purpose of this paper is to test option pricing to quantify the option to wait in a residential real estate fund divestment. It is argued that standard industry valuation practices miss the value of active fund management that should be included when planning a fund divestment strategy.

Design/methodology/approach

Dynamic programming, specifically binomial option-pricing model is suggested to complement the current industry standard valuation approaches. The approach is tested in an embedded case study where assets of a residential real estate fund are valuated using the model.

Findings

Option pricing can provide risk-neutral quantified value whether an apartment building portfolio should be divested in a single transaction or in multiple transactions over time. In the case study, an option value of 6.6 per cent was found for a residential real estate portfolio.

Originality/value

This study is the first of its kind to propose that value of waiting to divest is an important element when planning a real estate fund divestment. The approach proposed in this study risk-neutrally calculates the value appreciation from the range of the potential values. This provides the decision-maker a deeper understanding of the implications regarding the chosen line of action.

Details

Property Management, vol. 32 no. 5
Type: Research Article
ISSN: 0263-7472

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