Flexibility in Real Estate Investment

Author: Markus M. Harder

PhD Dissertation submitted February 2012 at the University of Cambridge

copyright 2012


Uncertainty about the future can have a considerable effect on current investment decisions. Investment in stages can help in spreading real estate development risk as it offers flexibility for an otherwise inflexible asset class. Here I present a continuous-time model that allows the valuation of a vertical phasing project with n stages as a perpetual compound option.

I find that the valuation of such a compound investment opportunity depends on parameters for all future stages, whereas the exercise policy per individual stage requires information solely on that stage; hence the optimal decision rule is independent of time, past stages, and future stages beyond the next.
Previously, no analytical solution to the vertical phasing option existed and similar issues had only been analysed with infinitesimally small steps and with no terminal stage. The solution presented in this research envelopes previous approaches and offers unique insights into flexible design with a finite number of discrete investment stages

To give a broader perspective, I compare and contrast the vertical phasing option to other possible investment alternatives and illustrate cases for which the alternatives are most preferable. Because flexibility comes at a cost, it must be carefully and separately evaluated for each potential investment opportunity.

For a manager the presented threshold policy is straightforward and easy to implement. Through practitioner interviews I offer insights into the current status of real estate investment analysis. Lastly, I provide models that have practical relevance and employ a simulation approach to create a refined investment analysis model that can be used by real estate professionals.


PhD Dissertation

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