The Application of Real Option to Valuation of Real Estate Development Project

Subject Areas : Financial engineering

Abbas Gomar ¹ , Amir Abbas Najafi ^{2 *}

1 - کارشناس ارشد مهندسی مالی، دانشکده مهندسی صنایع، دانشگاه صنعتی خواجه نصیرالدین طوسی، تهران
2 - دانشیار، دانشکده مهندسی صنایع، دانشگاه صنعتی خواجه نصیرالدین طوسی، تهران (عهده دار مکاتبات)

Received: 2016-03-04 Accepted : 2016-05-16 Published : 2016-09-22

Keywords: valuation, development, uncertainty, real estate, Real Option, Binomial compound option,

Abstract :

Recently, real option analysis has gained attention as an effective valuation method for complex real estate projects in developed countries. However, considering its potential, this method has not become as popular as it could have among developers in the country. One major reason may be its complexity and perhaps lack of finance knowledge and real estate data among Iranian developers .Thus, case studies can demonstrate the effectiveness of any theory and introduce real option analysis to Iranian devolopers as a standard valuation method. In this paper, case study analysis is used to examine the application of real options in real estate development projects. Comparison of valuations using traditional discounted cash flow with real option analysis brings out the relevance of real option methods in project decisions.Binomial method that values the project as a compound call option has increased the payoff of the project by 14% in comparison with net present value.