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Somerville, Tsur

University of British Columbia. Centre for Urban Economics and Real Estate

Real estate development from raw land to completed structures is a multi-stage process. Given the current view of development as the exercise of a real option, the question arises whether development should be modeled as a compound option. This paper tests the validity of the compound option characterization by determining whether builders start units for which they have permits and then complete units started in a fashion consistent with the predictions of the real options model. To do so, we first identify a reduced form relationship between permits and starts and then between starts and completions. The parameters of this relationship indicate how well permits proxy for starts and starts for completions. Then, we determine whether controlling for this structural relationship, new information and uncertainty in returns affect permit exercise and completion rates as would be the case if these actions were the exercise of real options. We find that current and previous quarter permits forecast current single family starts, while multi-family starts require more quarterly lags of permits. More than one and two year’s worth of lagged starts numbers are needed to estimate current quarter completions for single and multi-family buildings respectively. The principal result is that once building permits have been obtained, the development process proceeds to completion. While there is no evidence that completion is the exercise of an option embedded in a start, some aspects of starts are consistent with builders treating them as an option for starts. However, even if they do, it takes large changes in market conditions to affect small changes in starts.

Text

2017-01-24

Attribution-NonCommercial-NoDerivs 2.5 Canada

http://hdl.handle.net/2429/50416

Unreviewed

http://creativecommons.org/licenses/by-nc-nd/2.5/ca/