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The purpose of this paper is to deal with the appropriateness of using the Monte Carlo simulation as a technique to calculate risk in real estate development.

The paper is divided into two interlinked segments. The first segment examines the general definition of risk and Monte Carlo simulation methodology as a tool to estimate risk. The second outlines the appropriateness of using Monte Carlo as a tool to model real estate development, given the lack of data quality and its inability to account for human relationships in the development process.

It is important that the Monte Carlo Simulation model is used as prescriptive model that builds on the original elicitation procedures; produces initial results; allows for detailed sensitivity analysis and then remodels as required. In short, to be fully effective, the Monte Carlo Simulation model needs to be used in a complementary fashion with an understanding of human judgement and decision making.

A fuller analysis may include an examination of the uncertainties in each of the components of the appraisal and account for the appropriate distributions of each of these variables. This is generally referred to as a Monte Carlo simulation. The argument in favour of a Monte Carlo simulation is that it helps the appraiser have a better understanding of the possible outcomes for the development and the relative impact of each input in the pricing of the project.

A lot of work has been done looking at scenario modelling with probabilities and the results that ensue. However, it is important that these quantitative results are placed in the context of the heuristic and cognitive approaches adopted by the decision maker. In other words, the behaviour of the decision maker is as influential in the interpretation of the results as the numbers themselves. This paper looks at the advantages and disadvantages of using Monte Carlo simulation in this context.

This study contributes significantly to the practical application of probability‐based models to development appraisal. The findings of the study are useful for users of feasibility studies to understand the context in which a development feasibility is carried out, and for appraisers to extend the scope of their analysis when carrying them out.

This paper aims to analyse the appraisal of a specialised form of real estate – data centres – that has a unique blend of locational, physical and technological characteristics that differentiate it from conventional real estate assets. Market immaturity, limited trading and a lack of pricing signals enhance levels of appraisal uncertainty and disagreement relative to conventional real estate assets.

Given the problems of applying standard discounted cash flow, an approach to appraisal is proposed that uses pricing signals from traded cash flows that are similar to the cash flows generated from data centres. Based on “the law of one price”, it is assumed that two assets that are expected to generate identical cash flows in the future must have the same value now. It is suggested that the expected cash flow of assets should be analysed over the life cycle of the building. Corporate bond yields are used to provide a proxy for the appropriate discount rates for lease income. Since liabilities are quite diverse, a number of proxies are suggested as discount and capitalisation rates including indexed‐linked, fixed interest and zero‐coupon bonds.

The application of conventional discounted cash flow approaches to the appraisal of data centres requires information about a wide range of inputs that is difficult to derive from market signals or estimate analytically. In practice, discounted cash flow appraisals of data centre facilities are forced to incorporate non‐market assumptions that are inevitably subjective. Cash flows from data centres tend to be more complicated because of the high levels of current and capital expenditure compared with conventional assets. This requires an understanding of the appraisal of liabilities as well as income. Whilst the use of price information from similar cash flows such as corporate bonds is helpful, there are rarely assets and liabilities that have identical cash flows and risks and some approximation is necessary.

The digitalisation of business and society has produced a different form of real estate asset that is specialised, physically complex and whose operation, maintenance and management require specialist staffing and high levels of current and capital expenditure. The complexity of the cash flows and the lack of active trading create significant appraisal problems. This paper proposes an alternative approach to appraisal that utilises external pricing signals to appraise the various incomes and costs.