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Article
Publication date: 11 January 2008

Oliver Yu

The concepts of real options analysis, which transfer options analysis for financial investments to those involving real properties, such as land and plant facilities…

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Abstract

Purpose

The concepts of real options analysis, which transfer options analysis for financial investments to those involving real properties, such as land and plant facilities, have already existed for 30 years. However, the actual application of real options analysis to technology portfolio planning has not been as widespread as expected. Among others, a major barrier to such applications appears to be a lack of appreciation and acceptance of real options by technology executives. This case study aims to present a successful application experience of real options analysis to technology portfolio planning and highlights the lessons learned in overcoming such lack of acceptance and other barriers.

Design/methodology/approach

The paper uses a case study approach. The methodology focuses on describing the key issues and solutions for applying real options analysis in the technology portfolio‐planning process of a company.

Findings

The findings in this paper showed that considerable barriers exist in the acceptance of real options analysis for technology portfolio planning. However, the experience in the case study provides successful approaches for overcoming these barriers.

Originality/value

The paper shows that few studies are available on the difficulties of introducing real options analysis in practical applications. This paper provides a valuable case study for such applications.

Details

International Journal of Quality & Reliability Management, vol. 25 no. 1
Type: Research Article
ISSN: 0265-671X

Keywords

Article
Publication date: 18 November 2013

Graeme Guthrie

This paper aims to demonstrate the practical application of real options analysis to the evaluation of multistage projects, using an example involving a commercial real

2019

Abstract

Purpose

This paper aims to demonstrate the practical application of real options analysis to the evaluation of multistage projects, using an example involving a commercial real estate development.

Design/methodology/approach

The approach demonstrated builds on static discounted cash flow (DCF) analysis and requires knowledge of only the binomial option pricing model.

Findings

Real options analysis can be implemented in a spreadsheet and only one parameter – the volatility of the price of the completed project – needs to be estimated in addition to those required for static DCF analysis. The approach described can be used to evaluate a project at any stage of development, which is especially useful when the suspension of partly completed projects is under consideration.

Originality/value

The paper shows how to carry out real options analysis of complex multistage development projects using straightforward valuation tools, making an important project evaluation technique more readily available to practitioners.

Details

Pacific Accounting Review, vol. 25 no. 3
Type: Research Article
ISSN: 0114-0582

Keywords

Article
Publication date: 2 August 2013

Francesco Baldi

Real options available to developers and leading to an active and dynamic development of real estate assets are numerous. The purpose of the article is twofold. First, a…

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Abstract

Purpose

Real options available to developers and leading to an active and dynamic development of real estate assets are numerous. The purpose of the article is twofold. First, a conceptual framework is proposed as a practical aid for recognizing and understanding some frequently recurring combinations of options (such as deferral and expansion options). Based on the definition and classification of real options available in real estate markets, a comprehensive valuation tool for quantifying the value of those options embedded in a real estate development project is thus developed using a portfolio view.

Design/methodology/approach

Based on standard option pricing techniques, the proposed conceptual methodology is validated by applying it to an actual case of an investment for the construction of a new, multi‐purpose building in the semi‐central zone of the urban area of Rome (Italy).

Findings

Based on a static land value of €34.7 million, a waiting mode (deferral option) at an early stage of developing a property accounts for 16 percent of the expanded land value of the project, with 8 percent of such value being contributed by the expansion option. A real options valuation of the options portfolio available to a real estate developer enables increasing the project value by 31.1 percent as opposed to a traditional DCF analysis. In line with financial options theory, values of real options increase as volatility rises.

Practical implications

The case‐based analysis highlights that: flexibility in real estate development may create additional value enabling real estate developers or funds to react to market trends as new information arrives and uncertainty on fundamental factors (e.g. property prices) unfolds; the extra value added by managerial flexibility is neglected by DCF/NPV techniques; contrary to the common criticism on its lack of rigor, option valuation theory is suitable for appraising real estate assets; a portfolio approach is crucial when multiple real options exist.

Originality/value

Active management of real estate investments in response to changing property market and technology conditions confers operating flexibility and strategic value to appraisal of development projects beyond what is traditionally captured by a DCF model. An options approach to valuing and managing real estate development may change the developer's perspective altogether. Based on the combination of an original classification and a portfolio view of options existing in real estate markets, a real options framework for assessing the value of strategic flexibility incorporated in a greenfield development project (also accounting for potential option interactions) is designed.

Details

Journal of European Real Estate Research, vol. 6 no. 2
Type: Research Article
ISSN: 1753-9269

Keywords

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

1557

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

Article
Publication date: 17 May 2011

Jeffrey N. Street and Mukunthan Santhanakrishnan

Decision making for acceptance of an R&D project occurs under uncertainty and may involve predominantly quantitative analyses, such as net‐present value, predominantly…

Abstract

Purpose

Decision making for acceptance of an R&D project occurs under uncertainty and may involve predominantly quantitative analyses, such as net‐present value, predominantly intuitive analyses, such as real options logic, or some combination thereof. This paper attempts to bring together two concepts of decision theory, i.e. heuristics and framing, and real options logic into one integrated view relative to R&D project valuation. It is believed that the integration of theory helps explain expected and unexpected decisions resulting from the R&D project valuation process.

Design/methodology/approach

It is proposed here that, under a typical R&D project review, aspects of two theoretical concepts integrate to aid project valuation and decision making. The aim of this paper is to develop a research framework leading to advancement in the understanding of the relationship of heuristic principles from decision theory and the valuation methodology of real options logic. Findings – As a conceptual paper, propositions and a research model representing the conceptual framework are presented.

Research limitations/implications

Stemming from the propositions and research model, it is believed that the degree of influence that heuristics potentially exhibit on real options logic can be successfully measured. Confirming the degree of influence is a matter for future empirical research.

Originality/value

The originality of this paper is to develop a research framework leading to advancement in the understanding of the relationship of heuristic principles from decision theory and the valuation methodology of real options logic. In this framework, heuristics has been positioned as a moderator affecting project valuation derived by real options logic.

Details

Journal of Strategy and Management, vol. 4 no. 2
Type: Research Article
ISSN: 1755-425X

Keywords

Article
Publication date: 3 August 2018

Kwabena Mintah, David Higgins and Judith Callanan

Uncertainties in residential property investment performance require that real estate assets are designed in a flexible manner to respond to impacts of market dynamics…

Abstract

Purpose

Uncertainties in residential property investment performance require that real estate assets are designed in a flexible manner to respond to impacts of market dynamics. Though estimating the cost of flexibility is straightforward, assessing the economic value of flexibility is not. The purpose of this study is to explore the potential practical application of real option analysis to determine the economic value of a switching output flexibility embedded in a residential property investment in Australia. The study involves the exploration of an optimal strategy for investment in a residential development through real option analysis and valuation of a mixed use investment.

Design/methodology/approach

The real option valuation model developed by McDonald and Siegel (1986) is adopted for the evaluation because the switching output flexibility is likened to a perpetual American call option with dividend payout.

Findings

Through real option analysis, the economic value of switching output flexibility of the mixed use building was determined to be higher than the initial upfront costs. Moreover, a payoff of about $4million was determined to be the value of the switching output flexibility, therefore justifying upfront investments in flexibility as an uncertainty and risk management tool.

Practical implications

This application is an important demonstration of the practical use of options pricing techniques (real options analysis) and delivers further evidence needed to support the adoption of real option valuation in practice. Flexibility can also enhance risks and uncertainty management in residential property investment better than the adjustment of discount rates.

Originality/value

There is limited evidence on the use of real options techniques for the valuation of switching output flexibility in practice, and this comes as an original application; both the case study and data are all initial applications of switching flexibility in the Australian property market.

Details

Journal of Financial Management of Property and Construction, vol. 23 no. 2
Type: Research Article
ISSN: 1366-4387

Keywords

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

Keywords

Book part
Publication date: 13 August 2007

Jeffrey J. Reuer and Tony W. Tong

This paper categorizes and critiques the empirical research strategies that have been employed to test real options theory. Existing research has sought to detect valuable…

Abstract

This paper categorizes and critiques the empirical research strategies that have been employed to test real options theory. Existing research has sought to detect valuable options in firms’ strategic investments as well as to investigate the payoffs from these investments. Our review highlights some of the evidence that has accumulated in recent years for real options theory. We flag some of the most important challenges and tradeoffs associated with the use of different empirical research approaches for testing real options theory in strategic management. The paper concludes by offering a number of research priorities to advance the theory by probing its descriptive validity as well as by addressing its normative aspirations to bridge corporate finance and strategy.

Details

Real Options Theory
Type: Book
ISBN: 978-0-7623-1427-0

Book part
Publication date: 13 August 2007

Jaideep Anand, Raffaele Oriani and Roberto S. Vassolo

This study analyses the determinants of the value of a portfolio of real options and explores implications for strategic management. It focuses the analysis on four…

Abstract

This study analyses the determinants of the value of a portfolio of real options and explores implications for strategic management. It focuses the analysis on four elements: the number of real options in the portfolio, constraints on the number of options that can be exercised, the volatility of underlying assets, and the correlation between underlying assets. These elements are articulated around a trade-off between growth options and switching options and are applied to different strategic situations of technological, market, and macroeconomic uncertainty.

Details

Real Options Theory
Type: Book
ISBN: 978-0-7623-1427-0

Article
Publication date: 6 December 2017

Kwabena Mintah, David Higgins, Judith Callanan and Ron Wakefield

Real option valuation is capable of accounting for uncertainties in residential development projects but still lacks practical adoption due to limited evidence to support…

Abstract

Purpose

Real option valuation is capable of accounting for uncertainties in residential development projects but still lacks practical adoption due to limited evidence to support application of the theory in practice. The purpose of this paper is to use option valuation to value staging option embedded in residential projects and compare with results from DCF to determine which of the two methods delivers superior results.

Design/methodology/approach

The fuzzy payoff method (FPOM), a real options model that uses scenario planning approach to generate a range of figures, from which a single-numerical value is computed for decision-making.

Findings

The results showed that the use of a range of figures was able to represent uncertainties to a higher degree of accuracy than the static DCF. As a result, the FPOM was able to capture about 3 per cent of the value of the project that was missed by the DCF. The staging option offers an opportunity to abandon unprofitable phases of a project, thereby limiting downside losses. Thus, real option models are practically applicable to cases in property sector.

Practical implications

Residential property developers must consider flexibility in financial feasibility evaluation of development because of the embedded value in uncertain property projects. It is important to account for optionality in financial evaluation of property projects for value maximisation.

Originality/value

The FPOM has been used for the first time to evaluate a horizontal phasing of a residential development project.

Details

International Journal of Housing Markets and Analysis, vol. 11 no. 1
Type: Research Article
ISSN: 1753-8270

Keywords

1 – 10 of over 64000